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advisor insights

How advisors approach mutual funds versus ETFs depends, in part, on whether they’re stock-pickers or prefer to rely on portfolio managers to identify market opportunities.William_Potter/iStockPhoto / Getty Images

Sales of exchange-traded funds (ETFs) outpaced those of mutual funds in 2018 for the first time since the global financial crisis, driven by their lower fees and the growing number of products for financial advisors and investors to choose from. Still, Canada’s ETF industry, with about $170-billion in assets under management (AUM), is just a fraction of the $1.5-trillion in AUM held in mutual funds, according to recent data from the Investment Funds Institute of Canada (IFIC).

Mutual funds remain an important part of many Canadian investors’ portfolios, bringing comfort to some investors. IFIC and Pollara Strategic Insights’ 2018 Canadian Mutual Fund Investor Survey shows Canadian investors “continue to have more confidence in mutual funds than in other investment vehicles” including ETFs, equities, bonds and guaranteed investment certificates, “with this confidence rising compared to last year.”

As a result, there are times when mutual funds are a better option for clients – despite the massive growth of ETFs, some advisors say.

Active management can protect from downside risk

Simon Tanner, principal financial advisor with the Dynamic Planning Partners team at Investia Financial Services Inc. in Vancouver, says he relies more on mutual funds in the later stages of a market cycle. He prefers the more active management style as compared to more traditional, passive ETFs.

“In later-stage markets, a good actively managed mutual fund can maximize returns and limit volatility more than an ETF can and alleviate the emotional ride for investors on the downside,” says Mr. Tanner.

In addition, if a mutual fund portfolio manager is doing a good job of protecting assets when markets fall, it can prevent clients from panic selling, he says.

Although fees for mutual funds are often higher than those for ETFs, they’re starting to come down across the industry, Mr. Tanner says. Furthermore, he adds that clients don’t mind paying a little bit extra in fees if they feel their portfolio is being managed actively, particularly when markets are more turbulent.

The choice of whether to use mutual funds or ETFs in a client’s portfolio usually depends on the client’s financial goals and tolerance for volatility.

“Are they trying to mirror the market as cheaply as possible, or are they looking for downside protection in volatile times and upside participation in good times?” Mr. Tanner says. “As advisors, it comes down to understanding our client’s goals and appetite for risk.”

Getting expertise in certain market sectors

Mr. Tanner also uses mutual funds to get expertise in certain market sectors, such as technology. Instead of buying a technology ETF, for example, he might buy a mutual fund that has an active portfolio manager who picks stocks and their weightings based on current market conditions instead of passive funds, which just track the underlying index.

How advisors approach mutual funds versus ETFs also depends on whether they’re stock-pickers or prefer to rely on portfolio managers to identify market opportunities.

“I’m not a stock picker,” says Mr. Tanner. “I can put together a great portfolio with best-in-class managers and investments that meet the client’s goals and expectations, but managing the [investment] portfolio individual holdings? In my view, that’s better left to someone whose job it is to do that all day long.”

David Boyd, vice-president and portfolio manager with the Boyd Wealth Management Group at BMO Nesbitt Burns Inc. in Windsor, Ont., says mutual funds are often well-suited to newer investors seeking “instant diversification, without having to do a bunch of heavier asset-allocation lifting.”

For example, Mr. Boyd says many ETFs don’t rebalance on their own, which means investors need to stay on top of the trades to keep their portfolio balanced. Although there are some actively managed ETFs that balance based on asset allocation, they’re less common.

A good strategy for hands-off investors

Mutual funds can also be a good strategy for more hands-off investors who want to leave the stock picking to a fund manager, he adds.

“The ETF piece normally takes a bit more involvement with the client and their advisor or with their online portfolio,” Mr. Boyd says.

The choice comes down to how an advisor wants to customize a client’s portfolio. For example, investors looking for emerging markets exposure might prefer a mutual fund that has a portfolio manager with expertise in the region whereas someone trying to track the S&P/TSX Composite Index or buy broad exposure to the banks might pick an ETF.

“Everything is out there,” says Mr. Boyd. “It comes down to being aware of clients’ risk tolerance and the product risk. You also need to be able to explain it clearly to clients so they know exactly where their money is going.”

Dan Hallett, vice-president and principal at Oakville, Ont.-based HighView Financial Group, says the decision whether to buy a mutual fund or an ETF often depends on the exposure a client is looking for, such as North American or global markets, and what products the advisor has access to. Fees are also part of the equation.

“Our focus has always been on finding the investment exposure that makes sense for the client and then obtaining that exposure at a reasonable and competitive cost – whatever form that may take, whether it's a mutual fund or ETF or another product,” Mr. Hallett says.

The right product also depends on how active the investor wants to be, which can generate additional fees. For example, Mr. Hallett says, if a client does frequent transactions, such as monthly contributions or withdrawals, “mutual funds may make more sense to avoid frequent transaction costs.”

However, he says ETFs could still make sense if the transactions are larger or a little less frequent, such as quarterly instead of monthly, to reduce trading costs.

“My advice is to focus on clients’ needs,” says Mr. Hallett, “and let that lead to you to the [right] product.”