ETFs: Expansion plans

“As clients become more conscious of the effects of costs on returns,” says Daniel Straus, director of ETF research and strategy at Toronto-based National Bank Financial Ltd., “mutual fund companies are positioning [themselves] to offer their active management expertise in ETF format.”

Within a short period of time this past autumn, CI Financial Corp., Mackenzie Financial Corp. and AGF Management Ltd., (all based in Toronto), as well as California-based FMR LLC, operating in Canada as Franklin Templeton Investments Corp. of Toronto, have announced plans to enter the ETF business. Also jumping into the fray is TD Asset Management Inc. (TDAM), which will be launching a family of ETFs in early 2016, thus joining Royal Bank of Canada and Bank of Montreal, which already have carved out a spot in the ETF space.

“It’s an evolution rather than a revolution,” says Achilleas Taxildaris, head of manager research at Toronto-based Morningstar Canada. “The expansion has more to do with adding distribution rather than investment strategies.

“ETFs are simply another vehicle for fund [portfolio] managers to get their investment strategies out there,” Taxildaris adds. “The ETF structure is more cost-efficient than mutual funds, and may also offer some tax benefits to the end-investor. It is a positive evolution.”

The focus on transparent management fees as a result of regulatory initiatives, such as the second phase of the client relationship model, and technological advances giving rise to bare-bones automated financial advice services, such as robo-advisors, are spurring demand for low-cost ETFs.

As Canada’s $88-billion ETF market evolves, ETFs with underlying portfolios based on customized securities selection are growing faster than plain vanilla, passively managed ETFs based on broad market averages. Adding to this shift, mutual fund management companies entering the ETF business will be able to offer their actively managed products in ETF format.

“If I can sum it up in one word, the entry of the mutual fund companies was ‘inevitable’,” says Howard Atkinson, president of Toronto-based Horizons ETFs Management (Canada) Inc., currently the leader in Canada in developing actively managed ETFs. (Atkinson is slated to retire from Horizons as of Dec. 31.)

“If you’re a provider of investment products,” Atkinson adds, “it’s hard to have a complete set without offering ETFs. Once a few companies from the traditional fund arena move in [to offer ETFs], more will follow, whether they’re mutual fund managers or big banks.”

Atkinson says this move is “fantastic” for investors, as it will add to product and provider selection, with the increased competition putting downward pressure on the costs of professional investment management. Even though actively managed ETFs normally have higher fees than their index-based ETF counterparts, the former’s fees typically are lower than comparable mutual funds. Lower fees lead to better net return, and to better chances for an active portfolio manager to beat the relevant benchmark index.

The traditional ETF space in Canada is dominated by big players such as the iShares division of BlackRock Asset Management Canada Ltd., Vanguard Investments Canada Inc. and BMO Global Asset Management Inc., (all of Toronto), Atkinson says, and any new entrants must be “either a scale player or a niche player” to compete.

“The world doesn’t need another low-cost, market index-based ETF. That’s becoming repetitive,” Atkinson says. “The next phase is factor-based or quantitative strategies, all the way to fully actively managed ETFs – and that’s in the mutual fund companies’ wheelhouse.”

Traditional mutual fund firms are entering the ETF arena in a variety of ways, from acquisition to developing their own products. CI Financial has bought ETF provider First Asset Capital Corp. of Toronto, which has 42 ETFs with $3 billion in assets under management. AGF Management is acquiring a majority stake in Boston-based FFCM LLC, which has a family of alternative and smart-beta ETFs and is a subadvisor to AGF.

Competition for talent also is heating up. Franklin Templeton’s U.S.-based parent has hired Patrick O’Connor, formerly a senior executive at U.S.-based BlackRock Inc., as head of global ETFs to develop ETF capabilities. And Mackenzie hired Michael Cooke last spring as senior vice president and head of alternative investments, luring him from his former post as head of distribution for PowerShares Canada, the ETF division of Invesco Canada Ltd. of Toronto.

Mackenzie Financial, in a statement in November, stated that it is “committed to delivering solutions that help investors, and, as such, wants to deliver active management expertise to a larger audience.”

TDAM has confirmed it will launch a family of passive and active ETFs. TDAM has been successful in providing low-cost, index-based strategies through its E-series mutual funds. The firm also has a suite of actively managed mutual funds and is known for its fixed-income expertise.

“The proliferation of ETFs is becoming somewhat overwhelming for investors, and even [financial] advisors are being challenged by the multitude of choices,” Atkinson says. “Proper asset allocation and construction of an ETF portfolio increasingly requires sound methodology and expert advice. There’s a growing role for ETF portfolio strategists or asset- allocation programs, including the automated programs provided by robo-advisors. It’s not just a matter of throwing together a bunch of funds.”

Atkinson says that with more ETFs evolving from straight duplication of market indices, it’s important for advisors to know exactly what types of asset exposure those ETFs offer, and how individual ETFs “counterbalance and complement each other.”

Diversified exposure to asset classes such as real estate, global markets and alternative assets that are not correlated to traditional Canadian fixed-income and equities markets can be achieved by ETFs at reasonable cost, he says, offering potential for smoother returns.

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