A matter of choice

As more responsible investing (RI) ETFs hit the market and continue to evolve in sophistication, RI mutual funds may have more competition for assets. But both RI mutual funds and RI ETFs should continue to attract assets as investor interest continues to grow.

In Canada, RI accounts for 50.6% of assets under management (AUM), up from 37.8% two years ago, according to the 2018 Canadian RI Trends Report published by the Responsible Investment Association (RIA). The leading RI strategies by AUM are environmental, social and governance (ESG) integration; shareholder engagement; norms-based screening; and negative screening.

Canadians are particularly interested in RI because they have serious concerns over how environmental factors will affect their future well-being – more so than any social or governance issue. The 2018 RIA Investor Opinion Survey found that 81% of respondents were concerned about climate change and said it would create risks for the global economy within 20 years. As a result, 66% of survey participants said they want a portion of their portfolio to be invested in companies that provide solutions to climate change and environmental challenges. That makes RI an increasingly important selling point for clients.

When it comes to product offerings, mutual funds have been a popular choice for investment companies because they have represented the best structure for implementing ESG factors via active investing, as well as being more accessible (financial advisors registered with the Mutual Fund Dealers Association of Canada still face barriers to trading ETFs).

“In these circumstances, a firm could hire a subadvisor who would run either a traditional investment portfolio or an ESG-focused portfolio that the firm could then overlay with their own internal data analysis and their shareholder engagement process,” says Fred Pinto, senior vice president and head of asset management at Toronto-based Aviso Wealth Inc.

Now that ETFs have advanced within the past five years and are no longer just passive vehicles – witness the proliferation of actively focused and smart-beta ETFs in addition to passive ETFs – Aviso Wealth’s asset-management division, Toronto-based NEI Investments, is considering introducing ETFs to its suite of RI products, Pinto says.

The majority of RI-focused mutual fund providers, such as Toronto- based RBC Global Asset Management Inc., Toronto-based Mackenzie Investments, Toronto-based BMO Global Asset Management Inc. and LĂ©vis, Que.-based Desjardins Global Asset Management Inc., already have RI-focused ETF offerings on the table.

Some advisors say mutual funds offer more choice for RI investors than do ETFs, simply because there are fewer ETFs than mutual funds in Canada that are managed to an RI mandate.

Anthony Edwards, investment advisor at Courtenay, B.C.-based Ethic Invest, which operates under the umbrella of Leede Jones Gable Inc., says he tries to strike a balance between ETFs and mutual funds when building portfolios for clients.

Because many securities in an ETF are selected based on quantitative criteria, such as low carbon emissions or high ESG scores, companies that don’t fit those criteria get excluded from the index, Edwards says. Many of his clients want to move beyond exclusion and be more discerning, so they can effect greater positive change with their investments, which mutual funds enable them to do.

For example, Edwards’ clients who are interested in impact investing want active fund portfolio managers to support and invest in positive change with companies that are producing energy-efficient applications, water purification or reclamation of waste water, among other initiatives.

“That kind of thing is generally not available in the ETF space, so they’re willing to pay the extra 1% or 1.5% for mutual funds if they’re going to feel much better about their investments,” Edwards says.

However, Edwards’ associate investment advisor, Joss Biggins, who primarily serves Ethic Invest’s millennial clients, says his clients are a bit more cost-conscious, making ETFs more attractive. “They want companies they invest in to get their carbon emissions down as much as possible,” Biggins says, “but they also don’t want to get their [management expense ratio] too high.” He says ETFs take a greater share of his portfolios.

One area in which mutual funds still appear to have the lead is in providing exposure to global markets, which Canadian RI-focused ETFs have only recently begun to track. Edwards still turns to RI- focused mutual funds because “there is much more choice when it comes to getting global exposure [to RI] in the mutual fund space.”

Jay Aizanman, director of strategy and distribution at Desjardins Global Asset Management, says he sees a convergence of mutual funds and ETFs over the long term.

“When you look at the Canadian investment market at the retail level, there are a lot of opportunities for investment managers to take their investment strategy [currently mainly used in mutual funds] and put it into an ETF,” he says.

And, given that mutual fund disclosure rules also govern ETFs, fund managers are not required to reveal their underlying investment strategies, as is the case in the U.S. As such, Aizanman predicts much more active management in ETFs in the coming years.