As exchange-traded funds continue to surge in popularity, Bank of Montreal is aggressively expanding its offerings in pursuit of a piece of that highly competitive market.

BMO — the newest player to break into the Canadian ETF space — launched nine new ETFs in late October, bringing its total suite of ETF offerings to 13.

The BMO launch comes at a time when assets continue to flow rapidly into ETFs. Although the market remains only about 5% of the size of the mutual fund market in Canada, ETFs are quickly gaining ground. Toronto-based Barclays Global Investors Canada Ltd. reports that in the first 10 months of 2009, $5.9 billion in net new assets flowed into ETFs. This represents almost half of the $12 billion in net long-term inflows to mutual funds during the same period.

Canada’s iShares series of ETFs, the first to launch in Canada, dominate the $27.8-billion Canadian ETF market with an 80% market share. Two other players, BetaPro Management Inc. and Claymore Investments Inc., both based in Toronto, each hold about 10% of the market, according to data from Barclays Canada.

So far, investment firms have been reluctant to enter the highly competitive ETF market, particularly as other companies have been unsuccessful in their attempts. For instance, State Street Global Advisors Ltd. dabbled in the Canadian market, but axed its only Canadian ETF in 2002. TD Asset Management Inc. also entered the market earlier this decade, but announced the termination of all four of its ETFs in 2005, citing a lack of investor interest and low trading volumes since their creation.

Heading BMO’s venture into the EFT marketplace is Rajiv Silgardo, formerly president and CEO of Barclays Canada. Silgardo says the BMO team is hoping to carve a niche in the market by providing ETFs that give investors more choice and flexibility in building a portfolio. For example, three of BMO’s new ETFs offer investors exposure to equities in specific sectors: BMO S&P/TSX Equal Weight Banks Index ETF; BMO S&P/TSX Equal Weight Oil & Gas Index ETF; and BMO S&P/TSX Equal Weight Global Base Metals Hedged to CAD Index ETF.

“The idea of each of these,” Silgardo says, “was to give inves-tors the ability to implement more precisely their views about a particular industry or a particular sector of the equities market that they want to invest in.”

A similar idea is behind three of BMO’s fixed-income ETFs: BMO Short Federal Bond Index ETF; BMO Short Provincial Bond Index ETF; and BMO Short Corporate Bond Index ETF. Dividing the short-term, fixed-income asset class into three separate funds allows inves-tors to control the type of fixed-income exposure they hold, Silgardo says: “It gives them exposure to the fixed-income market, but also allows them to invest in a much more precise way than had been available previously.”

Two of BMO’s other ETFs also fall into the fixed-income category, and the bank is planning to add others in 2010 as fixed-income products surge in popularity.

Two-thirds of the money flowing into ETFs so far in 2009 has gone into fixed-income funds, says Oliver McMahon, director of product management with iShares Canada, a division of Barclays Canada. He says this has been part of a broader flight to fixed-income investments since the stock markets’ precipitous plunge in 2008.

“All of our fixed-income ETFs have been growing since the start of [2009],” says McMahon, adding that investors are turning to the ETF space for diversified fixed-income assets because these products represent a cheaper alternative to buying a fixed-income mutual fund.

Larry Berman, chief investment officer at Toronto-based ETF Capital Management, which helps clients build portfolios of ETFs, points out that most fixed-income mutual funds are very similar to their underlying indices in the same way ETFs are. Says Berman: “The reality is that 85% of the fixed income portfolio managers rarely deviate from the index.”

Although the best managers of fixed-income funds might beat the index by a whisker, Berman says, their higher fees generally eliminate any net gains, making a lower-cost ETF a better choice.

Berman expects BMO’s High Yield U.S. Corporate Bond ETF to be popular in the current environment of low interest rates because it offers a return that compares favourably to other fixed-income investments. But, he warns, high-yield corporate debt can be volatile.

@page_break@“You want to be cautious when you’re allocating a significant amount of your portfolio to high-yield [investments],” he says. “In terms of fixed-income, it’s the most aggressive you can be.”

As of writing, Claymore was planning to launch its own high-yield bond ETF in the first week of December. Claymore president Som Seif says that although BMO’s new funds may mean more competition, he’s pleased to see BMO’s entrance into the ETF market: “It’s good to see a bank in the business. They have a great brand. So, them coming into the business lends credibility to the fact that ETFs are an important part of the future of the investment market.” IE