Creating a “sphere” of ETF products

Sphere’s principals acknowledge keen competition among Canada’s 16 ETF providers, but they perceive a massive opportunity in stealing market share from the behemoth mutual fund industry as investors become more aware of costs.

“Our plans are a testament to where we think the ETF business is going,” says Lewis Bateman, Sphere’s founder and CEO. “[Financial] advisors can come to us for a differentiated, succinct platform of products that can help them enhance their value proposition to clients.”

The firm’s plan is to provide investors with a “sphere” of balanced products to serve investors’ various financial goals and risk/reward profiles. The firm has four ETFs listed on the Toronto Stock Exchange, including Sphere FTSE Canada Sustainable Yield Index ETF and three other regional ETFs with a similar sustainable yield strategy; these ETFs focus on Asia, the U.S. and Europe, respectively. A fifth product focusing on emerging markets is expected to be available later this summer.

Differentiating factors

“Sphere is one of a handful of new entrants coming in that are differentiating themselves by product features rather than offering the lowest-cost ETFs,” says Daniel Straus, director of ETF research and strategy with National Bank Financial Ltd. in Toronto. “[The ETF market] is fiercely competitive, the incumbents are dominant and some are trying a bit of everything to see what sticks.”

Adds Rudy Luukko, investment funds and personal finance editor with Morningstar Canada in Toronto: “Can a small, privately owned firm compete in the ETF business? Yes, but that depends on how well its ETFs perform over time and how successful [the firm] is in forging relationships in the advisor community. All the competition is in strategic beta now, and even the established passive index providers are introducing more actively managed ETFs.”

Sphere’s product family is unusual in that all of its equities-based ETFs have the same management fee of 54 basis points (bps). When fixed-income ETFs are introduced this autumn, the entire fixed-income family will have a common fee that will be less than that of the equities ETFs.

Keith McLean, Sphere’s president and chief investment officer, says the 54-bps fee is below the average of 61 bps for strategic- beta ETFs in Canada. Sphere isn’t trying to compete with “cheap as chips” ETFs that offer exposure to broad market indices based on the market capitalization of underlying holdings, he says, as these plain-vanilla ETFs with exposure to Canada can have management expense ratios of less than 10 bps. Instead, Sphere’s goal is to offer sophisticated, factor-based strategies with the potential to improve on broad market benchmarks by offering higher returns, fatter yields or less volatility.

The equality of costs across all geographical regions that Sphere’s ETFs offer allows investors to diversify globally, McLean says, noting that at least 60% of Canadian invested wealth is concentrated in the domestic stock market.

Sphere’s suite of low-volatility equities ETFs are aimed at investors who want a smoother ride and better sleep at night. A suite of high-return ETFs, aimed at growth-oriented investors, are slated to appear this autumn.

Sphere also expects to launch its first fixed-income ETF, which will focus on the Canadian market and employ a short-duration defensive strategy. Next will be U.S. and international fixed-income products and a real property/infrastructure ETF. Ultimately, the plan is to put together multi-ETF portfolios.

Continued expansion

Sphere’s executive team foresees continued expansion fuelled by trends such as an industrywide shift among advisors to a fee-based business model. With greater disclosure rules, there’s growing client awareness of product fees and their impact on portfolio performance, particularly in a lower-return environment, and this awareness bodes well for ETFs.

The factor-based strategy underlying each Sphere ETF is designed to compete favourably in a market in which various ETF providers are hoping to outperform basic, market-cap weighted ETFs.

For example, Sphere’s original suite of sustainable-yield ETFs is based on indices that go beyond the general subset of dividend-paying stocks to focus on a narrow group of 150 companies that must meet specific criteria to ensure sustainability of those dividends. Sphere and London Stock Exchange Group’s FTSE Russell global index provider worked together to design a customized index methodology based on such characteristics as a company’s share liquidity, profitability, operating efficiency, past dividend-payment record and ability to pay dividends without borrowing.

“Extremely high yields can indicate risk of a dividend cut rather than strength and quality,” says McLean.

Sphere’s Canadian ETF has a dividend yield of 4.4% as of June 30, vs 2.9% for the broader market. Each holding in the Sphere ETF is required to pay a dividend higher than the market average.

Prior to joining Sphere, McLean was head of equities with Toronto-based CQI Capital Management LP. He also did stints as a portfolio manager with Winnipeg-based Investors Group Inc. and McLean Budden Ltd. of Toronto.

Bateman has a background that includes sales management and business development at First Asset Investment Management Inc. and Horizons ETFs Management (Canada) Inc., both of Toronto.

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