ETF series of mutual funds, introduced in the Canadian market some 10 years ago, are gaining in popularity.
An ETF is a stand-alone investment fund, while an ETF series is an exchange-traded class of securities offered by a conventional mutual fund.
In 2023, 30% of new ETFs were new ETF series of existing mutual funds or launched with an accompanying mutual fund series, according to TD Securities Inc. Further, ETF series of mutual funds totalled nearly $50 billion in assets under management (AUM) — or about 10% of total ETF AUM in Canada — by the end of 2023, according to Investor Economics.
“Mutual funds have had bad press in recent years, not least because of their management fees. To remain competitive, fund companies have had to innovate,” said Julie Hurtubise, senior investment advisor with TD Wealth Private Investment Advice in Montreal. “Having an ETF series of a mutual fund was one way of responding to these negative perceptions.”
Another reason for the rise of ETF series is they are mainly actively managed, and active strategies themselves are quite popular.
“In Canada, approximately one-third of ETF assets are actively managed or non-indexed,” said Laurent Boukobza, vice-president and ETF strategist, Eastern Canada, with Mackenzie Investments.
Further, securities regulations do not require actively managed ETFs and ETF series to disclose their positions daily. This has “created a favourable environment for managers to feel comfortable making their successful mutual fund strategy readily available as an ETF series, so as to accommodate the portfolio construction of clients who prefer the ETF structure,” Boukobza said.
BMO Global Asset Management has issued 40 ETF series representing $26 billion in AUM, making it the country’s largest issuer of this structure.
“The offering of mutual fund ETF series continues to grow. And we’re seeing growing interest not only from mutual fund representatives, but also from securities representatives,” said Erika Toth, director, institutional & advisory, Eastern Canada, with BMOGAM.
Adding an ETF series to an existing fund allows portfolio managers to carry out larger transactions, which can reduce transaction costs relative to creating a stand-alone ETF, Hurtubise said.
“The larger the assets under management, the more efficient the fees. What’s more, if there’s been a mutual fund version of [an ETF] for a long time, we can find out about the fund’s history and the manager’s strategy,” she said.
Why choose an ETF series
Financial advisors can perform block trades with ETFs more easily than they can with mutual funds, Hurtubise said, noting that block mutual funds trades aren’t possible on certain platforms.
An ETF series of a mutual fund may have similar fees to the fund’s F series, but “not all investors have access to the F series. If it’s a transactional account with a professional, or an individual trading on a discount brokerage platform, the ETF series will be the only way to access this product with the same fees as the F series,” Hurtubise said.
“Advisors are looking to lower their clients’ fees to improve the performance of their portfolios. If you can do that with ETF series of funds, then why not?” said Michel LaRue, senior wealth advisor and portfolio manager with National Bank Financial Inc. in Quebec City.
Toth said many ETF series of mutual funds “are increasingly offered with the same management fees as ETFs, so they’re very competitive.”
The products also have the advantage of allowing investors to acquire them through regular automatic contributions, which is not possible with most ETFs. (Some robo-advisors now allow automatic ETF trading.)
What’s more, many fund issuers do not allow non-residents to purchase the majority of their mutual fund series, for operational reasons. However, because ETF series are exchange-traded they can be purchased by non-resident clients.
Challenges with ETF series
Mutual fund ETF series have drawbacks. For example, the performance of an ETF series may be different from that of any mutual fund series because an investor’s total return will be affected by the ETF’s transaction costs.
“ETF series are subject to comparable observable [bid/ask] spread costs [as stand-alone ETFs], plus those that occur on the underlying securities when the product manager buys or sells securities for the mutual fund trust. This reduces returns,” Boukobza said.
And, due to the pooled structure, ETF series unitholders must bear the transaction costs of their fellow mutual fund unitholders.
“An ETF not being able to externalize all costs of execution, as a result of sharing assets with a different fund structure, deprives ETF investors from one of the key benefits of ETFs,” states a TD Securities note to clients.
The pooled structure exposes ETF series unitholders to the risk of large inflows and outflows, which can reduce the ETF series performance. There may also be tax consequences for all mutual fund unitholders.
The pooled structure also restricts flexibility.
Some discretionary managers prefer to trade stand-alone ETFs because, “during a volatile market or an asset class downturn, they can have better control over their transactions than they would over a mutual fund series,” Toth said.
Some ETF series may not disclose their holdings daily. “This could have a major impact during periods of high market volatility, when the ETF’s market price could be significantly affected by changes in exposures and their values,” Boukobza said.
Advisors must understand how an ETF series differs from other mutual fund series and from a stand-alone ETF, and inform clients accordingly. “The advisor must work with complete transparency. It’s their responsibility to explain everything to their clients and present the characteristics of each structure so the client can make an informed decision,” Hurtubise said.
Boukobza agreed: “It’s best to make clients aware of the advantages and disadvantages of the ETF series, compared with the traditional mutual fund series, and to advise them on which structure is best suited to their particular situation.”
This article appears in the October issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.