How Canada’s ETF Market Differs From US

Despite similarities, the two markets face very different issues.

Reviewed by: Heather Bell
Edited by: Heather Bell

In Tyler Mordythe lead-up to the first Inside ETFs Canada on June 21-22, at the Fairmont Queen Elizabeth in Montreal, Forstrong President and Chief Investment Officer Tyler Mordy explains why a conference focused on Canada’s ETF-related issues is so important, and why a macro approach is good for Canadian investors. Why is it so important to have an Inside ETFs Canada conference?

Mordy: I've been involved with the Inside ETFs conference in the U.S. and other jurisdictions almost since the inception of the conference. The work that's gone into the buildup of the Canada conference has just been really encouraging to see.

I think the work that Matt [Hougan, chairman of Inside ETFs] and Dave [Nadig, Managing Director of] have done has been just phenomenal. I've called it the Davos of ETFs. It's become the place where thought leadership, debate and just progressing the industry has happened.

It's going to be an opportunity for perhaps Canadians to discuss some of their own issues that are not as relevant to American investors. I'm very happy to be part of it. Would you talk about the panel you’ll be on there?

Mordy: My panel is called "Adapt or Die: Managing a Bond ETF Portfolio in a New Regime," and it's all about income generation.

Obviously, we live in an era of low interest rates, and the defining problem of our time is what we've called a global income crisis.

When you're managing a bond portfolio—or a better phrase, income portfolio—the question you first ask, starting from first principles is, what problem are we actually solving? And the problem we're actually solving is how to generate some decent income without going too far out on the risk curves.

Traditionally, generating income as a conservative investor was quite easy when we had interest rates that were normal and we didn't have to deal with an era of financial repression.

ETFs have “colonized” the world's asset classes. And they've given portfolio managers a wider tool set with which to generate income or growth, or whatever the objective is.

The point of my presentation is that ETFs have facilitated a better income generation approach, in that we can look further afield for yield from all different asset types. Put it together in a diversified portfolio, and you can generate a decent income for clients without having to go further out on the risk curves.

One of the approaches that investors have pursued in recent years, because of low interest rates is, “within my balanced portfolio, I'm not earning any income on the bond component, so I'm going to go all into dividend-paying equities to increase my yield.”

The issue with that is that all of a sudden you've totally changed the nature of your risks, and where's the shock-absorbing component within the balance construct? It's just not there anymore. You're basically all equity risk.

We source income from around the world, and we don't compromise on diversification. The former strategy with the dividend-paying equities is concentrating equity risk. But the latter strategy relies on the only free lunch we have in finance, which is global diversification that generates a decent income without, again, removing that shock-absorbing component of the balance construct. Should Canadian investors be thinking differently than U.S. investors?

Mordy: The main difference for a Canada-domiciled investor is that your domestic investments are very different than your U.S. investments.

For example, in Canada, we have a very concentrated stock market; a lot of the exposures that Canadian investors would have are invested in banks and energy stocks.

Conversely, in the U..S., obviously you've got a much more diversified stock market, and therefore being a domestic investor in the U.S. just gives you automatically broader diversification. If you're in Canada, you're very concentrated in all those risks.

The second consideration is that a Canadian investor happens to have the misfortune of being in a currency block that is incredibly volatile. So any time we invest outside of our borders, we have to be incredibly cognizant of the currency risk we're taking.

But we’re big fans of active currency management. We believe currencies are very similar to any other asset class, like stocks and bonds. They can become overloved and overvalued; conversely, they can become underloved and undervalued.

That presents opportunity to go long in a currency or to just short a currency. Again, all that's facilitated through the ETF vehicle itself. Would you say that a macro perspective is of particular importance to a Canadian investor?

Mordy: Absolutely. I think with every commodity cycle—at least in Canada—you see Canadians fall in love with their own investments. They become overinvested in, for example, the oil sand stocks, the big bank stocks.

And when the commodity tide breaks, as it did in 2014, investors tend to overestimate their ability to pick the right stocks, and they underestimate the macro influences.

So obviously, the price of oil is going to be a huge macro influence; that's obviously a financial price that's determined not just within Canada, but globally.

Again, it's a tricky situation. There's a very strong case to run a macro approach simply because you see the outside influences affecting the country. I've always said that the world has progressively become more and more interconnected, but there have also been some rumblings about globalization going into reverse. That may be true at the margin, but over the last 30 years, world trade has expanded across borders, flows have expanded, and we've become intricately linked with each other. Your most recent SuperTrends piece talks about growth that's happening around the world. What's actually driving that?

Mordy: The post-financial crisis world—that's the world since 2008—has been characterized by strong risk aversion. The reason for that is what psychologists call “recency bias.” Because we went through a financial crisis, the most recent event tends to color the world that you see ahead. We've been living in this long shadow of the financial crisis.

Around the world at the policymaking level, we've had all sorts of responses on the monetary side—quantitative easing and so forth—and governments have fought it tooth and nail.

It's been strange at the corporate and investor level, because all these things should be bullish for financial assets, which they were, but they didn't really trickle down into the psyche of investors. If you look back in history, that's very typical of the period after a financial crisis—there tends to be a long period of risk aversion before economies really get going.

This time it's been no different. Ten years after the financial crisis, and only now there's a lifting of risk aversion. From a policymaking standpoint, the big regime shift here is a shift from relying on the monetary lever to stimulate growth to actually engaging the fiscal lever to stimulate growth. That's most notable in Europe where there's this steady retreat from austerity.

We're in a period where risk aversion is lifting, and everyone is getting more confident with the outlook for the global economy.

The U.S. recovered much more quickly than most other countries did. It deleveraged the quickest, and had the quickest policy responses. That growth is now being handed over to the rest of the world; most notably in Europe and emerging markets in Asia. And we see that continuing for the next year or two there. Are there any ETFs you're looking at as good ways to play that shift?

Mordy: Yes. In our portfolios we've been overweighting a lot of emerging markets. If you look back, markets really bottomed in the first quarter of 2016. That was when WTI oil was hitting $26 a barrel and there was some serious pessimism out there. The macro story told a little bit of a different story in that leading economic indicators were turning out, earnings were starting to recover as were emerging markets.

I like the iShares China Large-Cap ETF (FXI). The VanEck Vectors India Small-Cap Index ETF (SCIF) is also another one that we've been including in portfolios. Also, we like the development that's happening in Japan; so that would be the iShares MSCI Japan ETF (EWJ). It’s sort of a pack of three, a global growth portfolio, if you will.

Contact Heather Bell at [email protected]

Heather Bell is a former managing editor of She has also held editorial positions at Dow Jones Indexes and Lehman Brothers. Bell is a graduate of Dartmouth college and resides in the Denver area with her two dogs.