The exchange-traded fund industry is celebrating its 25th anniversary this month. The Globe and Mail asked Warren Collier, managing director and head of iShares with BlackRock Canada, for his perspective on how ETFs have evolved over the years, and what lies ahead.
What was the impetus behind creating ETFs?
The reason for creating ETFs was simple: to provide investors with a liquid, single vehicle for accessing Canadian capital markets. In the beginning, ETFs were primarily targeted at institutional investors who wanted a simple way to hedge exposure or equitize cash holdings; and for non-Canadian institutions specifically, the early ETFs provided simple, liquid exposure to Canadian markets. Since then, the appeal of ETFs has expanded way beyond institutional investors.
How have ETFs changed the investing landscape?
I think ETFs truly democratized investing. Compared with traditional mutual funds and many types of individual securities, ETFs provide greater liquidity, transparency, convenience and lower costs, and have increased the range and breadth of exposures available to the retail investor.
But beyond the product benefits, what ETFs have also done is to spark a real – and valuable – discussion about the value of advice and active management, particularly when you think about the high costs of active management, which has a very hard time matching index performance. This conversation has encouraged both institutional and retail investors to think more about asset allocation portfolios rather than trying to "beat the market," and ETFs have facilitated this strategic shift.
What have been the three biggest changes in ETFs since their inception 25 years ago?
First, what got us here won't get us there – the era of "one size fits all" is over. We need to continue to think in segments – the different products or uses of ETFs, as well as the different kinds of clients who are using them. Today we are seeing ETFs satisfy a variety of needs for our clients from core holdings to precise access to particular slices of the market to providing more efficient access over traditional vehicles like futures, bonds and more.
Second, we've seen a remarkable increase in the breadth of ETF users. Back in the early days, ETFs were embraced largely by institutions and, to a lesser extent, direct retail investors. But today an increasing number of financial advisers are deploying ETFs for a variety of uses, even as their popularity among institutional investors and self-directed investors continues to grow.
Finally, the industry has built out dramatically the breadth of exposures available through ETFs. Today, investors have the ability to build a low-cost, broad core portfolio with ETFs at the centre. It used to be that ETFs were seen largely as alternatives to mutual funds. But what we've seen, with the increasing diversity and breadth of offerings, is that ETFs are increasingly being used as alternatives to individual securities across both equities and bonds – they offer comparable or better liquidity, while also offering diversification within asset class exposures.
What has drawn investors to ETFs?
Initially, the attraction was low-cost, diversified exposures to the main Canadian asset classes. But investors have increasingly realized the other inherent benefits. ETFs are simple, they're flexible, and their costs and pricing are transparent.
As investors have become more familiar with ETFs though, they have continued to demand more from them. A good example is the evolution and the increasing popularity of fixed income ETFs, which have really exploded over the past couple of years given the inherent benefits of ETFs – transparency, real-time pricing, liquidity and low costs – which don't readily exist in many parts of the fixed income markets today. We don't see that stopping – and in fact we're doing everything we can to understand where investors want to go, and to help get them there.
How popular are ETFs among Canadian investors when compared to what you're seeing in the U.S.?
There are as many similarities as there are differences, but one of the differences is that Canadian investors are more global in their thinking. They're hungry for global expertise and knowledge, as well as for ways to access global markets.
The other difference is, obviously, in the regulatory landscape, which is evolving, and advisers and investors are looking for partners to help them navigate that change.
Canadians also appear more willing to try new things. ETFs as a category were created here, the first iShares funds were launched here, the first fixed income ETFs were launched here, the first currency hedged ETFs were launched here – I could go on. Contrary to the stereotype about Canadian conservatism, investors here are early adopters. And when we listen to them and build products to solve their problems, we lead the ETF industry globally.
The ETF industry has evolved considerably over the past 25 years. Where are you seeing clients engage in ETFs now?
I could point to any number of areas, but let me mention just two. One is the enormous growth in popularity of fixed income ETFs. We saw tremendous inflows throughout 2014, as investors are waking up to the cost efficiency, the price transparency and the liquidity of bond ETFs as advantages over the (opaque, increasingly illiquid and costly) over-the-counter bond market. I'm confident that this part of the industry is going to drive huge growth for a long time.
Another would be the enthusiasm with which investors have embraced our iShares Core here in Canada. Pretty clearly, they've been looking for greater cost-efficiency in core, long-term exposures – in part so they can dedicate resources to more tactical, outcome-based allocations – and the reception to the Core Series has been amazing. What we're seeing is investors using ETFs on the low-cost end to achieve beta, but increasingly also using them to play in the active-like space through tactical asset allocations. For instance, an investor can hold a Core Canadian equity fund, at very low cost, for long-term beta, and look to add "alpha" with more targeted like sector– or country-specific funds to achieve shorter-term outcomes.
I might also add that regulatory trends here in Canada are poised to change the way investors engage with ETFs. We think CRM2, for instance, while slow, will evolve the advisory space and potentially drive more advisers into fee-based compensation models. We think that's good for ETFs, and for investors broadly.
What do you think will drive the growth of ETFs over the next 25 years?
It's a really exciting time for the industry. We've seen remarkable growth over the first two-and-half decades of ETFs here, and I see strong growth continuing for some time. But just as significantly, we're seeing a real evolution in the way investors are using ETFs. To me, that's every bit as exciting as the continued expansion of the industry.
Those evolving uses are driving growth. Even the early-adoption segments, like institutions, are deepening how they use ETFs. But other segments are increasingly adopting them, too – a good example is bond buyers.
Given Canadians' more global outlook, we're also expecting a trend towards even more demand for ETFs that provide more sophisticated and broad global exposures.
We also think that ETFs are poised to grow in response to shifting demographics and the need for cost-efficient, convenient and transparent holdings in Canadians' retirement portfolios, and the increasing demand on Canadians to take a bigger role in their financial planning and management. Evolving distribution and advisory models, like online investing and digital advice, fit neatly with the simplicity and transparency of ETFs.
We think the trend toward fee-based advisory will continue to grow, with ETFs playing a significant role. We've been working with advisers moving to fee-based financial models for years now.
A promising new area of growth for the Canadian industry is the offering of an ETF-managed solution. Not only are traditional mutual fund managers or asset managers increasingly including ETFs in their own asset allocation strategies – more than two-thirds of institutional investors surveyed in a recent Greenwich Associates survey are using ETFs to achieve their core allocation strategies – but a new segment of "ETF Strategists" has arisen in the past few years. That segment has seen significant growth in the U.S., and is gaining momentum in Canada. While it's still early days here, we expect these trends to continue and the number of offerings to expand over the next few years, broadening access to a large, new group of investors in Canada.