ETFs: Past, Present and Future

■ How has the ETF market performed during the uncertain times investors have faced in 2020?

Fuhr: ETFs busted a number of myths. During the depths of the COVID-19 pandemic, we witnessed trading days with significant inflows and outflows. For the first four months of 2020, we saw net inflows globally for ETFs, which I think are also a good barometer of investor sentiment. For example, in April we saw that US$58 billion of net new money went into ETFs. More recently, we saw US$48 billion of net new money in May.¹

The majority of those investments went into fixed income ETFs, with investors searching for income and yield. We’ve also seen some of that investment go into commodity ETFs. For April, we saw some net outflows from equities, but if you went back to March, most of the money was going into equities. It’s interesting to watch how various investors are using ETFs, but I think the important thing is that people have continued to use them. It demonstrates the resilience of the ETF market. We’ve seen more money go into ETFs in the first four months of 2020 than at the same time last year.

■ Given these recent developments, how have fund manufacturers like TD evolved with the ETF industry?

McIntyre: If you look back just over 10 years ago, almost 100% of the inflows into the ETF business were going to passive solutions. Nowadays, this is a much different story, and we are seeing a large allocation going toward active solutions, especially in Canada. When you think about the capabilities of a firm like TDAM, with our core expertise in fixed income, equities and quantitative and factor strategies, the popularity of active ETFs is supported by the firm’s strengths. We’re expanding our ETF network in Canada, serving institutional investors, retail investors and advisors. In each of these categories, not only have investors been increasing ETF exposure consistently year over year, we believe that, based on conversations with advisors and clients, they plan on further increasing exposure to ETFs.

Cummings: We’ve seen the ETF market expand over the past decade. It moved from being mainly passive solutions to more specialized exposures, and then to quantitative and factor-based ETFs. Now, active strategies are an established segment of the market as well. While TDAM offers solutions in all four categories of products, we’re seeing increasing interest in quantitative and active ETF solutions. When you consider TDAM’s legacy of trust in fixed income and equity investments, the main difference now is we’re offering the same quality and diversity of solutions in an ETF vehicle.

■ How does this legacy of expertise translate into the ETF space?

Gossack: At TDAM, we have a wealth of expertise across many product lines. For any ETF provider, a solid offering starts with the company’s investment philosophy at the foundation of its products. We weren’t the first to come to market with an income generating ETF product, but we noticed there could be ways to improve the approach. We saw that there were product paradigms that had to be broken. With our active management philosophy, we were able to add new elements and new ways to solve client problems that weren’t being addressed in the market.

TD Active Global Enhanced Dividend ETF (TGED) came out of us talking to advisors and clients. There was a need for a truly actively managed global product. While it was easier for advisors to access the Canadian and U.S. markets, our global expertise was what we could bring to the table. We developed an actively managed ETF starting with a core group of quality companies, and then added a truly active options overlay to help enhance income. We did all this to help generate income while keeping total returns in mind, changing the product paradigm and giving advisors and investors solutions the market wasn’t providing.

■ Are the lines between passive and active ETFs starting to blur?

Cummings: I would submit that every investment decision is active. If you think about it, any asset allocation is an active choice. How much equity, for instance? Or how much fixed income versus cash? These are all active choices. As are any tilts or overweight positions in a portfolio to fit a client’s unique circumstances. Even the choice of which passive index to use is an active choice, because there are multiple index providers for certain given asset classes.

Some of these active choices may be fairly straightforward. But others may require relying on the specialized expertise of an ETF provider. This expertise might come in the form of a sophisticated options overlay on top of a high-conviction global equity portfolio, for instance. It might also come from actively designing a bespoke or customized index. For example, our product and portfolio management team here at TDAM actively helped design a unique index with index company Solactive to help fill a technology-stock gap in the market. In doing so, we now offer TD Global Technology Leaders Index ETF (TEC), which tracks a unique index currently exclusive to TD. TEC is an ETF that offers exposure to traditional technology companies, as well as new emerging companies not traditionally captured in other technology funds.

■ Actively managed ETFs seem to resonate with Canadians. Why is the demand for actively managed ETFs in Canada disproportionately higher than in other major markets?

Fuhr: If you look at Canada, about 22% of ETF assets are in actively managed solutions. Globally, the number is 2.8%.2 That’s a very big difference, and part of that comes down to how ETFs are regulated. In Canada, ETFs are regulated just like mutual funds. So, advisors and clients appear to have the confidence and flexibility to execute their strategies using both ETFs and mutual funds together. I think Canadians often look at ETFs to play a similar role to that of mutual funds, and sometimes passive indices alone don’t always reflect what investors actually want and need to invest in to achieve their goals.

On top of Canada being the first to launch an ETF, there’s also been a lot of innovation in ETFs in Canada. It’s often not about the “wrapper” of the ETF structure, it’s about the strategy inside of it, and how investors use it. And I think Canadian ETF providers have been successful at expanding the boundaries and evolving to develop tools that advisors and investors can use.

■ How can ETFs help enhance advisors’ practices amid the massive intergenerational wealth transfer occurring in Canada?

Cummings: One of the industry’s tailwinds is that younger investors seem very receptive to ETFs and technological innovation in the financial sector. Younger investors are not only asking their prospective service providers about ETFs, they expect their advisor to be proficient with them – it’s becoming one of those important boxes these investors want to see checked off. They may be needing advisors who can help them navigate the vast array of ETF solutions, in a forward-looking way.

Intergenerational wealth transfer represents both a great opportunity and great risk to an advisor’s practice. So, it’s important to engage this next generation. ETFs can serve as a tool to do that. Here at TDAM, we are equipped to help advisors deliver key educational engagement to prospects, existing clients and the families of existing clients.

■ Considering current trends in technology and regulation, what opportunities do these represent for advisors?

McIntyre: ETFs represent an important enhancement to practice management when it comes to an advisor’s business. Technology has played a big factor in the ability of investors to access information. In the past, advisors may have focussed their practices on being the supplier of that information to their clients. Today, these same clients have access to this information on their own. So, the type of communication that clients are having with advisors has changed. On the regulatory front, both in Canada and globally, there has been a focus on increased transparency in terms of fees, services an advisor provides and what clients are paying for those services.

As a result, we’ve seen a move from transactional advice, where advisors and clients are picking investments, into a more holistic view. Services like financial planning, estate planning, tax planning and behavioural coaching are how many advisors are articulating their value proposition as they move to a fee-based/discretionary model. ETFs have become a solution that advisors can use in this new model, whether it’s in discretionary portfolios or through tactical allocations. The other thing that we’re seeing is the ability for advisors to scale their business. Clients are getting older, demographics are changing,
average account sizes are getting bigger. ETFs have become a vehicle that fits very well into a discretionary portfolio building model.

Gossack: I’ve had the opportunity to meet with advisors across the country over my career. In the past, we spent a lot of time on the top 10 stocks we had in certain funds, because the main perceived value advisors brought to clients was security selection. These days, there are so many more demands on an advisor’s time, from identifying the right solutions for clients to ensuring there’s continuity between generations. An ETF represents one of many solutions that can allow advisors to focus more of their attention on their businesses and on their clients.

■ Where do you see alternative strategies heading in the ETF space, both in terms of investor demand and new products on the market?

Gossack: Many alternative products, such as leveraged solutions, commodities and infrastructure, were once only available to high net worth individuals or pension plans. It’s been part of the natural evolution of ETFs, as a democratic investment structure, to allow everyone to access these strategies. As the number one Canadian pension manager, as measured by Canadian pension assets under management,³ and the recent acquisition of a well-known alternative investment firm, TDAM is well positioned to offer such options to clients.

As previously mentioned, ETFs have been regulated in the same way as mutual funds. In the past, leverage hasn’t been permitted, but we’ve since seen some easing of these rules. That has allowed the industry to introduce new infrastructure and real estate solutions – at TDAM, we’ve launched TD Active Global Infrastructure Equity ETF (TINF) and TD Active Global Real Estate Equity ETF (TGRE). Alternative ETFs allow us to create tools that can help solve for various investor goals.

Fuhr: In the alternatives market, real estate solutions have been popular. In today’s interest-rate environment, clients have been looking at other ways to get income. This is happening globally, and this has been echoed in Canada as well.