When Terry Shaunessy started his own investment company in 2001, becoming one of the first firms in Canada to invest exclusively in exchange-traded funds (ETFs), clients had a lot of questions.
ETFs had been around for just more than a decade at that time, but many investors remained either unsure or unaware of the pooled investment product promoted as cheaper, more liquid and transparent alternatives to mutual funds.
“We spent the first five years explaining what ETFs are,” says Mr. Shaunessy, president and portfolio manager at Calgary-based Shaunessy Investment Counsel Inc.
Mr. Shaunessy, who had been tracking the development of ETFs since the mid-1990s when he was in previous asset-management roles, recommends ETFs as a simpler, low-cost way to diversify investments and meet asset-allocation targets.
“ETFs have basically made it easier [to invest],” Mr. Shaunessy says. “The best way to manage risk is to keep it simple.”
It’s a product pitch that he and other financial advisors have been making since not long after the first ETF – Toronto 35 Index Participation Units, which were known as TIPs and tracked the TSX 35 index – was listed in Canada on the Toronto Stock Exchange exactly 30 years ago on March 9, 1990.
ETFs are among the fastest-growing financial products in Canada, driven by advisors – both human and robo – as well as interest among retail investors. They have reshaped how advisors put portfolios together, including a shift away from individual stock picking and toward low-cost, diversified funds as part of a broader wealth-management offering.
Total Canadian ETF assets under management (AUM) stood at $204.8-billion in 877 ETFs as of Dec. 31, 2019, according to National Bank Financial Inc. That compares with $89.6-billion in AUM and 410 ETFs at the end of 2015 and $38.4-billion in AUM with 161 ETFs at year-end 2010. In comparison, mutual fund AUM reached $1.63-trillion in Canada at the end of 2019, up from $1.23-trillion at the end of 2015, which is an increase of 32.5 per cent versus the 128.5-per-cent jump for ETFs over the same period.
“If you want to know what the industry really thinks of ETFs, follow the cash,” says Chuck Grace, a lecturer at the University of Western Ontario’s Richard Ivey School of Business, who teaches courses on personal investing, and a consultant to the wealth-management industry as managing partner and president at Bigger Picture Solutions Inc.
The simplicity and transparency of ETFs – as well as their ability to meet or even beat active fund managers at a low cost – is forcing advisors to define their business models more clearly, including “why they’re here and what they deliver for clients,” Mr. Grace says.
It’s no longer about beating the market, but instead offering broader wealth-management services, such as tax and estate planning, combined with some behavioural coaching to keep investors from making mistakes that might derail their financial plans.
“If [advisors] have built their practices on delivering alpha – overachieving the market net of fees – they’ve had a really hard time with that value proposition,” he says. “If you’re not licensed to distribute ETFs in today’s world, I’m sure you’re finding this quite frustrating.”
Som Seif, the pioneer of ETF investing in Canada, says ETFs began to build momentum in the mid-2000s when wealth managers started shifting their investments into the space.
“You saw advisors moving from traditional broker/stock picking/new issues to more fee-based discretionary portfolio advice,” says Mr. Seif, who built Claymore Investments Inc. into one of Canada’s first ETF companies before it was sold to BlackRock Inc.'s Canadian unit in 2012. He’s now president and chief executive officer at Purpose Investments Inc.
“ETFs have enabled advisors to become much more confident in going toward the portfolio management function,” he adds, including building exposure in areas outside of their expertise, such as gold, high-yield bonds or international stocks.
Steve Hawkins, president and CEO at Horizons ETFs Management (Canada) Inc. in Toronto and board chair for the Canadian ETF Association, says ETFs are empowering advisors to shift their business models from commissions to fee-based structures.
“ETFs are the new, efficient way of managing your business,” he says.
Mary Hagerman, portfolio manager with the Mary Hagerman Group at Raymond James Ltd. in Montreal, says she has seen the power of index investing through ETFs since the global financial crisis in 2008.
“The returns that a lot of the plain-vanilla indexes saw since the financial crisis have encouraged a lot of people to use ETFs” either combined with active investing or with an all-passive approach, she says.
As the number of ETFs continues to grow, Ms. Hagerman says advisors have gained more access to good quality, global and diversified products.
Her portfolios are primarily invested in ETFs that are passive or have rules-based strategies, also known as “smart beta,” with the goal of “extracting as much emotion from the investment process as possible,” Ms. Hagerman says.
ETFs have also shone a light on investment fees, which has been good for investors and advisors – particular for those with a fee-based or discretionary type of practice.
“It has helped with the message that the fees [clients] pay aren’t just for performance, but what should be a whole wealth-management process,” she says.
ETFs will continue to evolve amid the push for lower fees and greater transparency, as well as advancing trading technology to form new products, Mr. Seif says. Further into the future, he believes ETF and mutual funds sales could both be outpaced by another innovative technology.
“I think there’s going to be new structural stuff that will come in that may not be a unitized fund, like an ETF or mutual fund, but rather separate accounts that do the same thing,” he says. “You’re going to see, through technology and innovation in the next 10 to 15 years, flows potentially going that way. It doesn’t mean pooling in ETFs and mutual funds won’t be part of it, but I think there will be competitive angles on it as well.”
Mr. Seif’s belief is the next wave will likely come from innovators outside the traditional investment industry, which could also be positive for advisors.
“There will be an ETF 3.0. There will be a new structure come to market,” he says. “The question is, who will develop it? My guess is that it will be outsiders, not people who have a lot of legacy in the market.”
Mr. Seif’s advice to advisors: “Pay attention to what’s going on and focus on the trends. Solve for the job that’s there, which is helping clients meet their goals, not beating the [market].”