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Since ETFs tend to focus on popular or well travelled areas of the stock market, there may be less money looking for a home in some of the market’s nooks and crannies.Getty Images/iStockphoto

Exchange-traded funds are attracting a lot of money, but is their rising popularity among investors leaving some areas of the Canadian stock market unexplored and rife with buying opportunities?

Stephen Takacsy believes it is.

The chief executive and chief investment officer at Montreal-based Lester Asset Management has been discovering a lot of cheap stocks and takeover candidates in Canada's small- and mid-cap spaces and he figures that ETFs just might have something to do with it.

"Despite a very expensive market, we have been seeing better and better opportunities in the past year," he said.

Why? A lot of the money flowing into ETFs is coming out of actively managed mutual funds. And since ETFs tend to focus on popular or well travelled areas of the stock market, there may be less money looking for a home in some of the market's nooks and crannies.

It's an interesting theory. According to ETF Insight, assets under management among Canadian ETFs totalled nearly $131-billion at the end of June, up 27 per cent over last year. The increase was driven by estimated net inflows of $15.5-billion in the first six months of this year.

The popularity of ETFs is easy to explain. They trade on stock exchanges throughout the day, making them easy to buy and sell. They're cheap, with management-expense ratios a fraction of what most actively managed mutual funds cost. And they are completely transparent and passive, since they tend to track indexes or follow well-defined investment methodologies.

There are now hundreds of ETFs to choose from, but the most popular equity funds tend to provide diversified exposure to major Canadian indexes, such as the S&P/TSX 60 index, and important sectors such as financials and energy.

But their popularity does make you wonder about how many stocks are being ignored by inflexible ETF mandates.

"It's creating great opportunities for small, active managers like us," Mr.Takacsy said. "We're not the only ones, but there aren't a lot of us out there any more."

Active fund managers aren't the only ones seeing untapped potential here. Cheap stocks are also being picked off by acquirers.

Among the stocks in the Lester Canadian Equity Fund – historically, about two-thirds of its holdings are small- and mid-cap stocks – two companies have been acquired in the past week, bringing the total to five companies in 2017, on top of seven companies in the fund that were acquired in 2016.

On Dec. 11, Pure Technologies Ltd., which develops technology to monitor critical infrastructure, announced that it had agreed to be acquired by Xylem Inc. for $9 a share. The deal gives existing Pure Technologies shareholders a 103 per cent premium over the stock's closing price on the previous trading day.

On Dec. 4, NAPEC Inc., which builds electrical transmission systems, announced that global investment manager Oaktree Capital Management Inc. will acquire the company for $1.95 a share. That's a premium of more than 35 per cent over the previous day's closing price.

Neither NAPEC nor Pure Technologies are included in the S&P/TSX 60 or the broader S&P/TSX composite index, which means that Canada's biggest ETFs wouldn't have noticed these companies.

Some ETFs track small-cap indexes, but they're not particularly large compared with more mainstream funds. For example, the iShares S&P/TSX Small Cap Index ETF has assets of $136-million – compared with more than $11-billion in the iShares S&P/TSX 60 Index ETF.

Active fund managers such as Mr. Takacsy also believe that the lesser known areas of the stock market – which can receive little attention from the media and financial analysts – are less efficient and therefore can benefit from the expertise of good stock pickers.

His track record suggests he may be onto something. To the end of November, the Lester fund has outperformed the S&P/TSX composite index over one-, three- and five-year periods. Results will no doubt get a boost in December from the gains in Pure Technologies and NAPEC.

As for what to expect next, Mr. Takacsy said he believes that Andrew Peller Ltd., Plaza Retail REIT and Ten Peaks Coffee Company Inc. are good opportunities that fit with his theme: Small companies that don't usually get much attention.

Perhaps more importantly, these stocks also aren't members of the S&P/TSX composite index, so the biggest ETFs are oblivious to them.

A look at Why active investors are jumping on the exchange-traded fund bandwagon