New ETFs offer core exposure

“We are looking to broaden our lineup,” says Stephen Hoffman, vice president of ETFs with RBCGAM. “And the new products are core, ‘centre plate’ ETFs offering diversified exposure to high-quality securities.

“Some investors are looking for income, and we have those products,” Hoffman adds, “while others are looking for total return, [for which] our core-equity products may be more appropriate.”

The five new products are RBC Quant Canadian Equity Leaders ETF; RBC Quant U.S. Equity Leaders ETF; and RBC Quant EAFE Equity Leaders ETF; as well as currency-hedged versions of the U.S. and EAFE ETFs. Furthermore, Mark Neill, head of ETFs at RBCGAM, says another quantitative equity ETF that will track emerging markets is in the works.

Unlike the “plain vanilla,” index-based ETFs that have dominated the industry, RBC Quant Equity Leaders ETFs do not track market indices. Instead, they use a multi-factor investment approach based on a predetermined set of rules. The approach is designed to avoid securities with low-quality earnings, poor growth rates and expensive valuations.

Traditional index-based ETFs typically weight securities based on market capitalization. Cap-weighted indices add to the weighting of a company when its share price – and, therefore, its market cap – is rising. Such increases can result in high price/earnings ratios within an ETF and often create an over-concentration in stocks that have rising momentum.

A rules-based approach such as RBCGAM’s offers customized strategies that will deviate from the benchmark index and may or may not beat the market during various periods – although beating the market is the intention in the longer term.

“In the world of ETFs, there is good representation from incumbent players [in] large, liquid, cap-weighted ETFs,” says Daniel Straus, associate research analyst, structured products and derivatives, with National Bank Financial Ltd. in Toronto. “But there also is demand for different strategies, such as those focusing on yield or risk management. There also has been a lot of interest in international ETFs, as people look for diversification outside the resources-heavy Canadian market – and RBCGAM has products to serve this demand.”

RBCGAM is trading upon its experience as one of the largest money managers in Canada and the largest provider of retail mutual funds.

“Our added value is our experience in active management, while many ETF providers are focusing on a passive offering,” Neill says. “Our screens are designed to find the best companies, based on [using] a forward-looking approach rather than the rear-view mirror. We are being thoughtful about what kind of ETFs we are launching. There’s no point in coming out with a product that already exists and competing on the basis of price alone.”

There is a component of active management in the design of the screens and rules used to select the individual securities underlying RBCGAM’s new ETFs. But the company is not contemplating launching any fully active ETFs, in which the underlying securities would be selected according to the subjective decision-making skills of a portfolio manager or in which the underlying portfolio would duplicate an existing, actively managed RBC mutual fund. Based on its market research, RBCGAM has determined that there is not significant demand for fully active ETFs. Clients tend to prefer mutual funds when seeking active management.

“Our family of ETFs complements what we are doing in the mutual fund arena,” Neill says. “The two types of products are used by different people for different reasons.”

Trends such as the switch by many financial advisors to a fee-based model and the growing scrutiny of costs under the second phase of the client-relationship model (CRM2) will support growth in ETFs. These factors were influential in RBCGAM’s decision to remain active in the ETF industry, Neill adds.

Because RBCGAM’s rules-based ETFs are more sophisticated than those that simply duplicate an index, they are priced higher than plain-vanilla ETFs, but still cost less than most mutual funds.

“We are not looking to be the lowest-priced provider,” Hoffman says, “but our products are designed to offer value [for] a fair price relative to the marketplace.”

Straus says RBCGAM has “approached the market cleverly,” gradually launching products as the firm builds its ETF technology, infrastructure and training programs, and introducing products that serve client needs.

While the firm has been in the ETF market for only four years, its growth has accelerated as its product line has expanded. In 2014, RBCGAM realized an “eye-popping” 300% increase in AUM, Strauss says, and has seen strong inflows in the first few months of 2015, gaining market share.

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