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.”
Differences: United States Vs Canada
One of the biggest differences between Canada’s and the U.S.’ ETF industries is the actively managed ETF structure. In Canada, active ETFs don’t have to disclose daily holdings. Hawkins says regulators mandate that ETF issuers of actively managed ETFs have a minimum amount of quarterly disclosure. Horizons typically discloses at least the top holdings of its actively managed ETFs on a monthly basis.
How often and how much they disclose “really depends on how proprietary the underlying strategy we believe it is from a disclosure perspective,” Hawkins said.
Elisabeth Kashner, CFA, director of ETF research at FactSet, says that in Canada, there’s less of a tradition of daily portfolio transparency, and separately there’s a greater prevalence of active management. She notes FactSet has a lot more difficulty getting daily portfolio disclosures from the Canadian side than the U.S. side.
Hawkins said that investor appetite for these types of ETFs is growing: “[Horizons] really focused our actively managed mandates in inefficient asset classes, primarily fixed income.”
TSX’s MacKenzie and CETFA’s Dunwoody both say that demand for fixed income ETFs is growing, for a few reasons. Of the top 20 ETFs by AUM, six are fixed income, with two in the top 10.
“I think that’s directly correlated to investors and advisors essentially finding ETFs are a significant better vehicle than the traditional access to fixed income,” MacKenzie said.
Dunwoody says it’s much easier to trade bond ETFs than traditional bonds, adding that many issuers are strongly promoting these ETFs, which may account for their growth.
The interest in fixed income ETFs in Canada may also be a sign of the current market cycle, Kashner said: “In general, people put money into bonds when they’re feeling a little rocky about equities.”
CETFA’s Dunwoody says that Canadian investors are also showing interest in thematic and socially responsible ETFs, although given these types of ETFs are usually satellite positions, they don’t show up in the top 20 ETFs by AUM.
“They get the headlines and they get people interested,” she said. “But thematics are not going to be big chunks of people’s portfolios.”
Forstrong’s Tsang says they’re also seeing interest in asset allocation ETFs. First launched by Vanguard Canada in 2018, these are “fund of fund”-type ETFs that are like a globally diversified portfolio that invests in different sectors of the market. They’re very popular with investors with small positions.
“If you have a smaller account, say $5,000 or $10,000, you can easily access global exposure for a very low fee,” she noted.
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