Markets With Different Trajectories

January 01, 2020

After several sluggish years, Canada’s ETF  industry is growing, albeit at a smaller size than the U.S.

Granted, Canada is less populous than the U.S., but part of the story is also how the ETF industry matured there. Although ETFs were born in Canada, with the iShares S&P TSX 60 Index ETF (XIU) launching before the SDPR S&P 500 Trust (SPY), the ecosystem developed differently than in the U.S.

There are a few reasons for those different paths, Canadian sources observe. A large part of that is the structure of Canada’s financial industry, which is controlled by five big banks that issue mutual funds and essentially control much of investment vehicle distribution, limiting initial ETF industry growth.

But that’s changing. Pat Chiefalo, managing director and head of iShares Canada, believes the global trends of the rise of fee-based wealth advisory practices, the search for cost efficiencies from investors, and greater use of ETFs by institutional clients are changing Canada’s industry. “These are all part of the underlying, organic trends that are driving flows in our market,” he said.

Gathering Assets
As of Nov. 30, Canada ETFs have attracted $23.5 billion in fund flows year to date, notes Karen Tsang, director of ETF research and associate portfolio manager at investment firm Forstrong Global, citing data from National Bank Financial. That’s brought total ETF assets to $200 billion, she notes.

Andrew Pringle, senior investor relations intelligence analyst at Nasdaq, points out that in 2018, ETFs outsold mutual funds for the first time in a decade, and in 2019, net sales were at $19 billion versus mutual funds’ $12 billion.

“ETFs are getting some momentum, and two obvious setbacks for mutual funds are that Canada has some of the highest fees in the world and these products underperform indices 75% of the time. In short, ETFs are cheaper and typically better performing than actively managed mutual funds, and investors are starting to take note,” Pringle said.

Just as in the U.S., inflows into fixed income ETF products dominated, capturing $12.6 billion of the year-to-date flows. And equity ETFs took $8.2 billion of the flows, says Tsang. The move into fixed income ETFs reflects the rising uncertainty in the global economic outlook, with demand from institutional as well as retail clients, she adds.

Pringle suggests there might be lesser interest in Canada equity as the indexes haven’t had as strong a return as in the U.S., noting SPY has had a total return of about 69% for the past five years versus about half that for XIU. “When you’re looking at the TSX, it’s heavily weighted in financials and energy,” he said, “whereas in the U.S. you’ve had the tech boom.”

Yet flows don’t tell the whole story. Erik Sloane, head of sales at NEO Stock Exchange in Toronto, notes Canada’s mutual fund market by assets still dwarfs ETFs. According to The Investment Funds Institute of Canada, at the end of 2018, Canada mutual funds totaled $1.42 trillion. “I think if you look at size, mutual funds remain the heavyweight,” he noted, “but ETFs are catching up.”

Canada Banks Enter ETF Market
Pringle explains that Canada’s five main banks have now entered the ETF market, which is significant, since banks hold a lot of power over what people do bankingwise and investmentwise.

“Everything you do from opening a checking account can lead eventually to some kind of investment product,” he explained. “A huge reason investors are moving towards ETFs is that the big five banks have made a major investment in ETFs, and we’re seeing a lot of advertising and marketing for these products as a result.”

Chiefalo notes there are two sources of ETF asset growth in Canada. The bulk is organic, end-client demand, but a significant amount—although less than 50%—comes from the concept of “bring your own assets,” which is asset managers, like banks, pumping up their ETF assets under management.

Chiefalo and Sloane say that organic demand for fixed income ETFs in Canada is growing, partially driven by the economic uncertainty. Chiefalo adds that some of the demand comes from investors realizing that using ETFs are a more efficient way to access the bond market, because of transparency and transaction costs.

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