Special to the Globe and Mail
Published January 20, 2014
By Tom Bradley
Exchange traded funds (ETFs) are the most talked about product trend in the wealth management industry. I’m not sure what comes second, but it’s not even close. An overwhelming majority of commentators and bloggers recommend indexing with ETFs, some to the exclusion of all other products and strategies.
For the most part, the halo hovering over ETFs is well deserved. In an industry that’s characterized by high fees and reluctant transparency, these pooled funds have low fees and are easily understandable. There are funds for every nook and cranny of the capital markets, so investors can gain exposure to, or avoid, whatever risks they choose. For hedge funds and day traders, ETFs can be bought and sold at any time during the trading day.
But there is a disconnect here. The supposedly hottest product category has less money going into it in a year than RBC, TD and Manulife have going into their wrap products in a month. ETFs are the Target stores of the investment business.
Some numbers will clarify what I mean. According to Investors Economics, Canadian mutual funds and ETFs total slightly more than a trillion dollars. ETFs account for $63-billion or 6 per cent of that. Net flows into ETFs (purchases minus sales) in 2011 were $7-billion. In 2012, they were a little better at $12-billion, but for the year just ended, net flows dropped back to $5-billion.
If we compare Canada to the U.S. using the typical ten to one ratio, ETFs flows in Canada last year should have been $17-billion and total assets should now be in the neighbourhood of $170-billion.
Interestingly, the sales have been underwhelming at a time when ETFs had a strong tail wind behind them. Stock markets have been good, the number of ETFs (300) and ETF providers (9) has proliferated, and the prevailing shift from Canadian to foreign equities favour ETFs (and mutual funds) over individual stocks.
Besides a late start, I attribute the lack of traction in Canada to two structural forces – ETFs are not sold in bank branches and they don’t fit into the traditional commission-based compensation plans at the broker/dealers.
Bank branches now account for a large percentage of Canadian investment assets, which is a unique feature of our market. They offer mutual funds and banking products like GICs and structured notes, but ETFs are not accessible to customers. Not even the fastest-growing ETF firm, BMO, offers ETFs through its branch network (instead, they sell mutual funds that hold ETFs).
In the case of broker/dealers, commissions still rule the day. Advisor compensation for virtually every product in client portfolios, with the exception of individual stocks and bonds, has a commission built in. However, there are only a few ETFs that pay a trailing commission.
Fee-based accounts, which charge an annual fee based on assets, are gaining a foothold (good for ETFs), but commission-based products still rule the day.
In addition to Canadians’ dependence on branches and brokers, there are other reasons for the modest growth. One is inertia. It takes time for a trend to build momentum. Despite all the favourable press about ETFs, investors move slowly.
The hold of inertia was probably worse in 2013 due to returns. Index funds had a tough year in some of the bigger categories, which translated into less urgency to move. Fixed income ETFs, which have been sales leaders over the last two years, had returns hovering around zero due to a weak bond market, and Canadian equity ETFs lagged significantly behind actively-managed mutual funds.
Even though I’m a died-in-the-wool active manager, I find the ETF flows to be a major disappointment. I’m a believer in clients getting a fair shake, and for the most part ETFs are a better option than high-cost mutual funds that do little more than shadow the index.
I’ve been wrong on predicting the magnitude of this trend so far, but I still think indexing and ETFs will be a defining force in Canadian wealth management over the next decade. It’s just taking a little longer for the train to get going. Inertia and compensation are powerful things.