Markets With Different Trajectories

Although both are growing, the U.S. and Canada ETF markets have developed very differently over the years.

Reviewed by: Debbie Carlson
Edited by: Debbie Carlson

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.

Fixed Income Demand Growing
In that vein, there have been rising inflows into ultra-short-term savings/high interest ETFs, Tsang describes. As an example, she cites a relatively new ETF, the CI First Asset High Interest Savings ETF (CSAV), which invests in high interest savings accounts at major Canada banks, which has attracted nearly $1.2 billion year to date. It launched in June 2019. An older ETF, the Purpose High Interest Savings ETF (PSA), which debuted in 2013, has $2.4 billion in AUM. Both ETFs are in the top 20 ETF year-to-date inflows, she explains, citing NBF ETF Research data.

Robert Tull, president of ProcureAM ETFs, who in the past launched ETFs in Canada, notes that, for a long time, Canada’s fixed income ETF market wasn’t well developed, because Canada’s government didn’t have a deep enough pool for the ETF market to pull from.

He points out the early ETF market reflected Canada’s economy, which is heavily commodity-based in resources like metals and timber. In that sector, Canada also has a lot of smaller companies that are publicly listed as part of an incubator market within Canada’s biggest stock exchange, the Toronto Stock Exchange, known as TSX Venture.

“One of the things you have to look at when you’re dealing with Canada, is you need to understand it’s a smaller market, tends to be commodity regulated and tends to have smaller cap companies,” Tull explained, adding that, given this background, it may have spurred the interest in cannabis ETFs.

Growth Outlook
Tsang points out that new regulations passed in 2019 by the Canadian Securities Administrators established new rules governing “alternative mutual funds,” which also includes ETFs. That’s opened the door to introducing liquid alternative ETFs in Canada, with 11 ETFs launched year to date as of Nov. 30, representing nearly 8% of new launches.

There’s also been noticeable growth in asset allocation ETFs, she adds. These are “fund of fund”-type ETFs usually holding globally a diversified portfolio that invests in different market sectors. These are different from traditional Canada ETFs that are actively managed.

Twelve of these ETFs launched in 2019, representing 9% of all launches year to date, Tsang observes. The top four Canada providers—BMO, RBC iShares, Vanguard and Horizon—all have an asset allocation lineup. These are designed for retail clients, and that’s where demand is coming from, along with investment advisors, she notes. Canada retail investor growth rose 13.7% during 2018, Tsang says, citing Strategic Insight’s Q1 2019 report, versus institutional investor usage rising 10% during 2018.

“With retail being such an integral part of the growth of ETFs in Canada, it’s no surprise to see the continued growth of assets in these one-stop investment products,” she said, referring to the asset allocation ETFs.

Next Generation
Similar to the U.S., environmental, social and governance (ESG) ETFs are seeing strong demand, several sources note. Tsang points out 10 new ESG-focused ETFs launched in the first three quarters of 2019, with iShares Canada launching six index-based ESG ETFs in March, comprising four equity and two fixed income ETFs.

Pringle speculates that Canada may be seeing a “changing of the guard” when it comes to ETF use, similar to what’s happening in the U.S. “I’ve seen a lot of studies suggesting that older investors and older generations in general hold more money in mutual funds, whereas millennials and Gen Xers are more open to sort of everything from ETFs to robo advising to just a less active approach,” he said.


Debbie Carlson focuses on investing and the advisor space for U.S. News. She is an internationally published journalist with bylines in publications including Barron's, Chicago Tribune, The Guardian, Financial Advisor, ETF Report, MarketWatch, Reuters, The Wall Street Journal and others.