The Canadian ETF marketplace has come a long way from being the country that arguably launched the first publicly traded ETF, in 1990, to now gathering more asset flows than mutual funds.
According to the Canadian ETF Association and National Bank Financial, Canadian ETFs outsold mutual funds for the first time in 10 years, helping ETFs capture 10% of total investment fund assets. Net creations reached $20.9 billion in 2018, the second-best selling year, CETFA says. Mutual fund holdings still dwarf ETF assets, at $1.7 trillion in assets under management (AUM) versus $172 billion, respectively, but industry participants say ETFs’ market share will likely rise.
A number of factors favor ETF growth, market watchers say: lower fees versus mutual funds, regulatory changes, increased distribution, more issuers entering the field and improved education.
Despite introducing the world to ETFs in 1990, the Canadian ETF industry saw mostly slow growth for nearly the first 20 years. It wasn’t until the Global Financial Crisis that investor interest in ETFs started to pick up, sources say, and it wasn’t until about five years ago that AUM growth started to snowball.
Canada’s industry has now reached a tipping point where expansion will likely continue, says Kevin Gopaul, global head of ETFs at BMO Global Asset Management, the second largest Canadian ETF issuer by AUM.
“I believe Canada is going to grow faster than many jurisdictions in the world, just because the level of adaptation is increasing even more quickly than I could have modeled the breadth of users …,” he said. “I do see a path towards about 25% [of investment funds in ETFs], assuming the investment fund landscape continues to grow. I think the opportunity set is quite large here.”
In The Beginning
The Toronto Stock Exchange launched what many consider to be the first ETFs, the Toronto 35 Index Participation Units and the Toronto 100 Index Participation Units, eventually merging into the iShares S&P TSX 60 Index ETF (XIU). That fund remains Canada’s largest ETF by AUM, at C$9.3 billion. Canada is also home to the first fixed income ETF, the iShares Core Canadian Universe Bond Index ETF (XBB), which continues to trade, and has C$2.6 billion in AUM.
Graham MacKenzie, head of ETFs at TSX, says the first equity ETFs were broad-based exposure products geared to institutional investors looking for exposure to Canada and to use in portfolio transition. TSX is the dominant ETF exchange in Canada.
Despite these innovations, interest in ETFs languished, says Pat Dunwoody, executive director of CETFA. She says two factors impeded growth: the original commission-based compensation financial advisors received, and that bank-issued mutual funds prevailed in distribution.
“The product itself never took off, mainly because the Canadian industry is—and I guess this is where it’s different from the U.S.—very advisor-driven, not investor-driven,” she explained. “Products are sold, not bought, generally, and historically, our industry was a commission-based one and dominated by mutual funds.”
Size constraints also limited growth, as there were only two ETF issuers and not a lot of ETFs available for the first 10 years or so. Offerings increased as sector ETFs launched between 2000 and 2008, TSX’s Mac-Kenzie notes, and more issuers entered. Horizons ETFs launched its first ETF in 2007 as Canada’s third fund issuer, with BMO launching in 2009 as No. 4.
BMO’s Gopaul thinks ETFs’ passive index structure may have helped entice some investors to the vehicle during the financial crisis because holdings were transparent, ETFs were easy to implement, low cost and had varied investment offerings.
“When the financial crisis hit, and beyond, is when we started seeing a lot of flows into the ETF marketplace—tremendous flows,” he added.
The Industry Today
CETFA says there are now 36 ETF sponsors and 701 ETFs in Canada. The top four issuers are in order of AUM: BlackRock Canada, BMO, Vanguard Canada and Horizons ETFs, a subsidiary of Mirae Asset Global Investments.
Karen Tsang, director of ETF research and associate portfolio manager at Forstrong in Toronto, which has built ETF-only portfolios since 2003, says the increase in participants helped spur growth over the last decade by not only offering more and innovative products, but each firm has its own educational programs that help to raise industry visibility and awareness overall.
Steve Hawkins, CEO at Horizons ETFs, agrees: “I think there was a huge waterfall effect for all ETF providers simply based on ETF education that was taking place.”
Tsang notes the strong push by the big five Canadian banks is driving ETF business; the prime example being the RBC iShares partnership in January 2019.
Gopaul says banks initially hesitated to enter the ETF industry, concerned that ETFs would bite into their mutual fund business, but eventually banks saw ETFs as a way to broaden sales opportunities since they already had the distribution networks.
While ETFs are considered to be a retail product, Canada institutions are still ETF users. Tsang points to the 2017 Greenwich Associates Canadian Exchange-Traded Funds Study showing Canada institutions are leading the way in integrating ETFs into their portfolios. Greenwich’s survey of 52 institutions showed these organizations allocated an average of 18.8% of total assets to ETFs—the highest average allocation found in any of the five regional markets covered in the firm’s annual global research.
As in the U.S., robo advisors are a growing part of Canada’s landscape. These platforms also fuel ETF use since robos use ETFs for core portfolio construction, Tsang notes, adding that Forstrong is the biggest partner on the Wealthsimple for Advisors platform.
Regulatory change is the final driver for ETFs taking a bigger share of Canada’s investment funds, Tsang says. Financial advisors now must disclose their compensation, and many moved from commission-based compensation to fee-based business models.
Horizons’ Hawkins concurs, saying regulatory change affected how financial advisors managed their portfolios: “It really has changed the sentiment of mutual fund use and shifted it toward ETFs. It’s been a big positive.”