Som Seif, President and CEO, Claymore Investments, Inc., Toronto.
The popularity of exchange traded funds is exploding. There are hundreds of these investments now in the marketplace, and they're no longer just tracking well-known indexes. There are now ETFs that are actively managed and many are using increasingly complex financial instruments and strategies to try to outperform the market.
So where are the pitfalls and dangers? Which ones should Canadian investors focus on, especially with the volatile markets? And why should they be considered in the first place instead of a well-managed, low cost mutual fund?
Industry expert Som Seif joined us in a live discussion Thursday that covered these topics.
Som started Claymore Investments in Canada in January 2005 and leads the implementation of the company's business development and corporate strategies. Prior to joining Claymore, Som was an investment banker with RBC Capital Markets, where he worked since 1999. Som played a key role in developing the structured products group at RBC Capital Markets in both Canada and the U.S., where he structured and raised capital for both Canadian and U.S. asset managers.
Som is a Chartered Financial Analyst and has a Bachelor of Applied Science with an emphasis on Industrial and Systems Engineering from the University of Toronto. In 2011, Som was recognized for his vision and leadership by Caldwell Partners International with the Top 40 Under 40 award.
A full transcript follows:
Darcy Keith - Good morning everyone, I'm Darcy Keith, web editor with Globe Investor.
Darcy Keith - Welcome to this live discussion with Som Seif
Darcy Keith - We look forward to an informative discussion today on exchange traded funds. Please submit your questions at any time
Darcy Keith - Good morning Som
[Comment From Som Seif]
hello, looking forward to a great discussion
Darcy Keith - Let's start with a very broad question, coming from Brendan:
[Comment From Brendan ]
Why choose an ETF over mutual fund?
[Comment From Som Seif]
Hi Brendan, first ETFs and mutual funds actually compliment one another. But ETFs really are great at providing low cost, tax efficient investment products. There is a lot of focus on them because of their flexibility to invest how you want, but also their transparency, which most ETFs provide daily disclosure of holdings and strategy
[Comment From Chad Tennant, IA ]
As a fellow ETF advocate, the advantages far outweigh the benefits of traditional actively managed mutual funds. How many years before we see ETF AUM exceed that of mutual funds?
[Comment From Som Seif]
Hi Chad, i personally dont believe ETFs will exceed mutual funds in Assets. I think what you are seeing is a more leveling of the asset mix. See Canadians have historically been highly exposed to active management. Today, more and more people are differentiating the good active managers from the bad, and switching to ETFs in their place. I see ETFs and Mutual Funds having similar levels of assets 10 years out
[Comment From robbie ]
What is the best ETF for investing in the resource and precious metals area?
[Comment From Som Seif]
Robbie, first you need to decide if you want to buy equities or physical exposure (such as gold or silver). For energy equities, there are plenty products (broad such as XEG and broken down by segment, oil and gas, such as CLO and ZJO and ZJG. All provide different exposures...
[Comment From Som Seif]
For Precious metals, look at Broad Gold equity ETFs like XGD and ZJG, or Broader commodity ETFs like CMW. For physical metal, look at CGL for Gold and SVR for Silver
Darcy Keith - Just before we get to the next question, I thought our readers would be interested in checking out today's number cruncher. Rob Carrick took a look at which equity-focused mutual funds beat similar-themed ETFs. It was a pretty short list. https://www.theglobeandmail.com/globe-investor/investment-ideas/number-cruncher/funds-that-give-etfs-a-run-for-their-money/article2231066/
Darcy Keith - Our next question is from Chad:
[Comment From Chad Tennant, IA ]
Do you think actively managed ETFs counter the original intent and design of their first generation counterparts? Are you for? After all less and less active managers are beating the index to your previous point.
[Comment From Som Seif]
Its a great article by Rob, and it highlights the first point as to why more and more investors are looking at ETFs to replace mutual funds for long term investing.
[Comment From Som Seif]
I personally believe that traditional active management doesnt make sense in ETF structure. ETFs are great for low cost, low turnover and transparent strategies. If an active management can maintain these characteristics, then it can fit well inside an ETF. Otherwise, the strategy is best suited for a traditional mutual fund structure.
[Comment From richard ]
There was a big drop in the yield of your dividend fund this last year. Do you see that as a one time thing or will it continue to be volatile due to the market?
[Comment From Som Seif]
Hi Richard, CDZ is focused on companies that grow their dividend every year for 5yrs. This is really what drives the holdings, rather than absolute yield level. So last year we kicked out a bunch of companies that failed to grow their dividend and that is what caused the drop in yield. But the core to the strategy is what matters. But important, despite the lower yield, the total return has been fantastic. CDZ just crossed its 5 yr performance # and is top decile of all Canadian dividend funds and beat the benchmark dividend strategy by over 2% annualized. So yield matters, but strategy is more important.
Darcy Keith - A related question from Matt:
[Comment From Matt ]
What's most important when looking at the different Dividend ETFs? Yield? Cost? Performance?
[Comment From Som Seif]
Matt, i always say when investing, the strategy is the most important. You either have to believe its the right way to invest or not. Cost matters second, because the lower the closer you get to the real return. Yield is less important. Despite the dividend being important to long term returns, a high yield strategy doesnt necessarily mean better. Focus on what the strategy is and if you intuitively believe in it, thats why you invest.
[Comment From D Malkin ]
What are your thoughts on and responses to the problems of thinly traded ETFs (e.g. - CGR) and the potential for crowding in the marketplace as more providers duplicate most of the common and popular products?
[Comment From Som Seif]
Hi D, first its very important to understand that all ETFs have 2 levels of liquidity, and volume isnt the key to liquidity. ETFs are open end funds, and with the Designated Brokers posting bids/asks all day around the funds Net Asset Value, investors can buy and sell an ETF around NAV at anytime during the day...
[Comment From Som Seif]
So investors need to look at the bid/ask. With respect to new ETFs coming, i think its can be good innovation, but again, the most important thing to focus on is the underlying strategy of the ETF.
Darcy Keith - Som, I'm interested in hearing what ETFs are out there - and there are so many now - that retail investors should stay away from, no matter what. What funds are on your danger list? Or are worries about some funds that use complicated financial instruments overblown?
[Comment From Som Seif]
Darcy, its a tough question. See with the growth of the ETF industry, we've seen a lot of innovation, some good and some bad. I think the most important thing is understanding what an investor is trying to accomplish. Dont just buy an ETF because the name says something. Buy it because its strategy is good. Lots of questions around leveraged/inverse products. My perspective is that for majority of long term investors, these products dont make sense. But for investors who understand how these products work, they actually do deliver something that is hard to achieve...leverage and shorting capabilities. Same with commodities and other derivative based products. Its not to say they are bad, but you need to know how they work and what their expected outcomes will be.
[Comment From Chad Tennant, IA ]
The price of oil was pretty much flat through Oct 31st ($91.55 - $92.58). HOU, the popular Horizons leveraged commodity ETF was down 27.05% over the same period. Claymore does a great job of providing investor education, but do you think more needs to be done concerning complex ETFs that deviate from plain vanilla as to help investors make wiser decisions?
[Comment From Som Seif]
Chad, absolutely more needs to be done and can be done on education front. My view on the leveraged/inverse products is there is a problem of a gap of education/understanding. This needs to be fixed. It has somewhat because of what has happened over the past few years, your example noted. More needs to be done so investors dont buy the wrong product. Ultimately though, investors do need to take responsibility to learn about a product before putting their money in. That will save a lot of heartache.
Darcy Keith - Thanks Som. David has our next question:
[Comment From David ]
What would be the impact on fixed income ETF's such as CLF and CBO if any country out there defaults on its debts? Are these ETF's relatively safe? Would they survive a major credit crisis?
[Comment From Som Seif]
Hi David, first these two ETFs are Canadian fixed income, so you'd need a default of Canadian gov't or corporate issuers to affect them materially. In any event, if a default of a country like Italy was to occur, this would have a major impact on global bond funds (mutual funds and ETFs) that had exposure to Europe or to bonds of financial institutions that had exposure to Italy. Really important to understand whats inside the portfolio. But a Canadian bond fund shouldnt have any impact. CLF and CBO are very high quality investment grade bonds underlying
Darcy Keith - Two very similar questions now from Bill and Dan:
[Comment From Bill ]
What effect will the introduction of Vanguard have to MERs on ETFs in Canada?
[Comment From Dan ]
How do you think Vanguard's arrival will affect the ETF marketplace in Canada?
[Comment From Som Seif]
Dan/Bill, good question. First i think its good innovation because they are just taking the benchmark indexes and lowering the costs. Overall thats a good thing. My personal view though is that benchmark investing is already very cheap in Canada through XIU, ZCN, XSP and other cheap funds. I do think that Vanguard has a lot of work to do to educate investors and develop a brand in the market. They will need to show people the value of switching from an established product like XIU to their Canadian equity fund for what amounts to about 7 bps difference after all fees.
[Comment From Albin ]
I've bought some of your ETFs under the iTrade no commission arrangement - just wondering if you're planning to extend that to other brokerages.
[Comment From Som Seif]
Thanks Albin. We thing what Scotia iTrade has done is a great innitiative for Canadians bringing zero cost trading. That said, we do hope more platforms offer this. We think its a great thing for Canadians. Our goal is to make investing in ETFs as easy and cheap as possible.
Darcy Keith - Here's a question, left under comments for this article, from a user named 'portfofino':
Question: What percentage of ETFs are derivatives? How is the value calculated to take the fee? Finally, what transparency/controls are in place to ensure that these vehicles don't become overleveraged like the CDS/CDO market?
[Comment From Som Seif]
Good question, i'll answer the second question first. All ETFs and Mutual Funds charge management fees and they accrue daily based on NAV. Key difference with ETFs is that thay generally charge a management fee that includes all the operating expenses of the fund, unlike mutual funds...
[Comment From Som Seif]
Regarding use of derivatives...first, all ETFs in Canada are regulated as mutual funds and have specific rules about use of derivatives. This is how they are structured to not have these issues. If a derivative is used, like a mutual fund, there are limits on amount of exposure to any derivative and counterparty, they have to have 100% collateral, and all of it has to be in cash. This is very important. Lots of noise in Europe these days on use of Swaps and derivatives. But this is not a problem in Canada because our regulatory structure is very good at overseeing the products.
[Comment From Seamus ]
hello Som, one disadvantage I see with regards to EFT's is the fact that it is hard to dollar cost average your investments due to commission cost. This is one advantage that keeps a portion of my investments in mutual funds. If major brokerages do as scotia did and eliminate commission charges I would definitely take advantage of dollar cost averaging to . Do you envision major brokerages cutting such charges as scotia did in the future?
[Comment From Som Seif]
Hi Seamus, we agree, and thats why we actually launched the DRIP/PACC and SWP offering. We are the only firm in the world who offers Pre-Authorized Cash Contribution plan for ETFs (PACCs). So you can do this now on most platforms. Along with Scotia's no commission platform, Canadians can now dollar cost avg their investments like a mutual fund. BTW, i believe the discipline of dollar cost avg'ing is really a great strategy.
[Comment From Arthur Yip ]
Hi Som, I am interested in Claymore's justification for using RAFI Fundamental Indices. Have they shown to outperform comparable products? Have lower risks? Enough outperformance to justify its higher MER?
[Comment From Som Seif]
Hi Arthur, thanks for the question. We use the Fundamental Index strategy because its a better way to passively invest. Basics of it is it weights companies based on its fundamentals vs. market cap, trying to avoid the issue of linking price and weight together. The performance has been very strong. For example our Canadian RAFI ETF CRQ, has beat the benchmark over 5 yrs by over 1% annualized, but is also top decile of all Canadian equity mutual funds. The RAFI strategy really has been adding value. Passive investing is good, but you can be a little intelligent about how you actually select and weight companies.
Darcy Keith - Let's turn the discussion to interest bearing ETFs, and these two related questions from Bill and David:
[Comment From Bill ]
Som, which bond ETFs that produce higher yield do you like? Do you see them suffering when interests start to rise?
[Comment From David ]
Hi Som, your CLF and CBO ETF's have a yield of about 4 - 4.5%. How are you able to maintain such a good return when interest rates remain very low?
[Comment From Som Seif]
Bill/David, very important with bonds today because we are in a low interest rate environment, that Yield to Maturity is what every should always focus on. YTM is the coupon plus/minus the price movement of the bond back to par. Bond yields are meaningless. YTM is all that matters. With CLF and CBO their coupons are high because that is what the underlying coupons are and we have to pay them out, but the YTMs are much lower, more like 1.4-1.8%...
[Comment From Som Seif]
Regarding other bond funds, in the low interest rate environment, i believe investors should be looking to other areas such as corporate bonds, lower grade corporate bonds or HY bonds to get yield. If you assume that economies are improving and companies are doing well, then you can take some more risk with the quality of the bond to get yield. High Yield bonds currently are priced to give YTMs in the 7-9% range, which are very good. If you are worried about interest rates, look at something like CSD which has a nice yield, but also very low duration to avoid risks if interest rates start rising.
Darcy Keith - Here's a question from Bob, who has been patiently waiting for his chance (we've had many questions today!)
[Comment From bob ]
How does a "IA" get paid if he has me in ETF's?
[Comment From Som Seif]
Hi Bob, there are a few ways Advisors use ETFs with clients. First they may have a fee based approach where they charge the client directly a flat fee on all assets. Second, they may have a commission structure, where an Advisor charges for each trade of an ETF or a stock. Finally, an Advisor may use an ETF or mutual fund with embedded trailer fee. We have Advisor Class ETFs for this reason. Ultimately its very important that clients and Advisors discuss this and choose the best approach on an individual basis.
Darcy Keith - Here's a follow-up question from Brian, returning to the topic of bond and interest bearing ETFs:
[Comment From Brian ]
Does Claymore publish the current yield to maturity for its bond funds each day? If not how am I supposed to judge the investment without this information?
[Comment From Som Seif]
Hi Brian, yes on our website we publish the current Yield to Maturity daily (i believe its daily but i may be wrong and it may be update on a monthly basis as it doesnt change that often). We try to be as transparent as possible with this as its important.
[Comment From Mark ]
Is it just me or have the MERs on ETFs been creeping upwards a bit as they become more popular? Is that because of higher demand or because of more active management than the original ETF's (or both)
[Comment From Mike ]
Following up on Mark's question, what's a reasonable MER?
[Comment From Som Seif]
Hi Mark, actually there are 2 answers. First, the MERs on basic benchmark ETFs has actually been creeping downwards as more competition comes to the market and new players try to find ways to compete for investor attention. But the Avg MER of all ETFs has actually gone up, driven mainly by the gorwth of new strategy based ETFs and also new asset classes (e.g. commodities and other novel asset classes). Generally, the fees of an ETF are very competitive relative to the comparable active management products. But you do have to look at this more closely now. investing in Emerging Markets isnt and shouldnt be the same price as investing in Canadian equities.
[Comment From Bill ]
Related to Marks's question regarding MERs - since the introduction of the HST in Ontario, would moving to a different province help to lower fees?
[Comment From Som Seif]
Ha ha ha, we all looked at this quite closely. But the reality is no, otherwise we would have. First i think that HST on a mutual fund is a total tax grab. But the issue with moving to another province is that its where the servicing is done that matters. So all the costs of audit regulatory, etc. So its very hard to avoid. Finally, even if we moved to save a portion of it, there was no guarantee a province like Alberta wouldnt implement an HST like tax there in the future. So this is a real issue we all face.
[Comment From Joe ]
Are there any tax advantages of ETFs over Mutual Funds in a corporate/class structure?
[Comment From Som Seif]
Hi Joe, first i am generally a fan of Corporate Class mutual fund structure. I still think they are way too expensive in Canada. Regarding ETFs, because of the lower turnover of the underlying strategies and the structure of how the portfolio gets invested, ETFs have generally lower capital gains than high turnover mutual funds. Against Corporate Class funds, we have launched the Advantaged Series of funds which similarly have the ability to create more tax efficient income. What ETFs dont allow is the ability to switch inside the family on a tax exempt basis. It would be counterintuitive given they are exchange traded, so wouldnt make sense for ETFs to offer this.
Darcy Keith - I have to apologize to many of our readers who have asked questions that we haven't had time to answer. This discussion has been extremely popular ... and we'll have to have one again soon. For now, here's a final question from Dan:
[Comment From Dan Lokay ]
A general question on ETFs: Can you elaborate on the mechanism which ensures that the ETF is correctly priced relative to the underlying portfolio? Theoretically, every buyer or seller can do these calculations, but practically, it is hard to believe that they are capable of doing it. So it seems that, as a result of bursts of purchases or sales, the ETF price can deviate from the underlying value of the securities. Or is it the market maker (for example Calymore?) which has the task of assuring "fiarness" of the ETF price (in addition to the usual role of a market maker of a single stock)?
[Comment From Dan Lokay ]
Thanks in advance.
[Comment From Som Seif]
Dan, the key to this is that an ETF (unlike a stock) is an open end fund. So new demand or supply is met through creations of new units or redemption back to the fund. So by virtue of this, the market makers (not Claymore, but the major banks in Canada are our market makers) can effectively post a bid and an ask in the market very close to the underlying ETFs Net Asset Value at all times during the day because if they sell units to meet demand, they will just create units at NAV. If they buy units back because excess supply, they will just redeem at NAV back to the fund.
Darcy Keith - Thanks Som. This has been a great discussion that's been useful I'm sure to many of our readers. Are there any final thoughts you'd like to leave with our audience today?
[Comment From Som Seif]
Thanks everyone for the great questions. A lot of fun
Darcy Keith - For those who many not know, we have a great page here at Globe Investor for more information on ETFs. You'll find valuable data, such as most active ETFs of the day, and many news articles and features.
Click here to check it out
Darcy Keith - Thanks to all for joining us today!