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Investors injected about $35.5-billion into Canadian ETFs last year, pushing the industry’s overall asset value to $314-billion at the end of 2022, down slightly from $323.1-billion end of 2021, according to National Bank data.aprott/iStockPhoto / Getty Images

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Ongoing market volatility and fears of a prolonged economic downturn could limit the rapid growth of exchange-traded funds (ETFs) this year. However, experts believe the ETF sector will be nimble by continuing to slash costs, cut product fees and provide more market-relevant products to attract and retain investors.

“I don’t think 2023 will hold a candle to 2021, which was the post-pandemic, Fed-stimulated, meme-stock crazy, crypto booming, stay-at-home day-trading, near-insanity bull market in terms of flows,” says Daniel Straus, director of ETFs and financial products research at National Bank Financial Inc. in Toronto. “But it will still be very positive and strong.”

Investors injected about $35.5-billion into Canadian ETFs last year, pushing the industry’s overall asset value to $314-billion at the end of 2022, down slightly from $323.1-billion at year-end 2021, according to National Bank data. Last year’s ETF sales were driven by sales in high-interest-savings (HISA) ETFs, which helped to offset broader losses caused by falling stock and bond markets.

With markets expected to toss and turn again this year, HISA ETFs, also known as cash ETFs, are expected to remain popular alongside other fixed-income and alternative asset products aimed at reducing investment risk.

Mr. Straus anticipates “an enormous number” of ETF launches this year. One area, in particular, is single-stock ETFs, which are increasingly popular in the U.S. and recently landed in Canada in the form of five “yield shares” ETFs launched by Purpose Investments Inc. in December.

He also sees a “proliferation” of alternative ETFs, such as market-neutral hedge fund strategy and commodity futures that did well in 2022, which could “grab some of the spotlight in 2023.”

Still, recession fears, made worse by the growing list of corporate layoffs – including at ETF providers such as fund giant BlackRock Inc. – could be a reason for some providers to “reconsider their lineup and maybe make some consolidations,” Mr. Straus adds.

No widespread fund closures

Elisabeth Kashner, vice president and director of ETF research and analytics at FactSet Research Systems Inc. in San Francisco, says the ETF industry is unlikely to give up ground during an economic downturn, especially larger players that make up the vast majority of ETF assets in the U.S.

However, she expects the industry to become leaner as providers streamline operations due to falling profits amid the market selloff.

“The ETF business is hugely competitive,” she says. “As fee compression continues, asset managers have no choice but to run their operations as efficiently as possible.”

Ms. Kashner doesn’t anticipate widespread fund closures as a result of market volatility.

“I don’t think advisors need to be worried that everyone’s favourite funds are about to close,” she says, adding that fund closures can happen even in strong markets, and there are often other ETF options.

“I think most advisors have the opposite problem – too much product and how to make sense of it.”

She says it’s too early to speculate on how the ETF industry will perform this year but believes core, portfolio-building ETFs should stand their ground, while more complex or niche products might bring more risk.

“A simple strategy is to do your due diligence on your core portfolio and ignore the noise,” she says.

Dan Bortolotti, portfolio manager and certified financial planner at PWL Capital Inc. in Toronto, believes HISA ETFs will remain popular in 2023, assuming interest rates remain elevated. Not only do they offer higher yields than most savings accounts, he says, but the products are liquid and well-diversified, with the ability to spread exposure across many banks.

“It’s a product that has really shown its usefulness in the last year or so,” Mr. Bortolotti says.

He also sees tax-efficient ETFs as being more popular for non-registered accounts. For example, with the sharp increase in interest rates last year, discount-bond ETFs should now be expected to deliver much of their future return as capital gains, which are taxed at half the rate of interest income.

“Even though we reached maturity a long time ago in the ETF industry – and most new products are fringy and useless – there are still a couple of new products that are interesting, as well as some older ones that are becoming more useful,” he says. “It’s not about the current state of the market or what’s hot.”

Investors taking ‘barbell approach’

Raj Lala, chief executive officer of Evolve Funds Group Inc. in Toronto, says his firm will continue to build out its fixed-income offerings after the success of its HISA and covered-call ETFs last year.

“We’ve not really been viewed as a fixed-income ETF provider, other than our HISA fund, and that’s something I would like to change,” he says, citing the growing interest in fixed-income ranging from cash ETFs to bond funds.

“It’s an area that we’re definitely taking a closer look at and trying to identify where there might be some gaps that we could potentially fill.”

Mr. Lala says any bond product would be an active strategy using a third-party manager similar to its existing partnerships with Addenda Capital Inc. and Allianz Global Investors.

Mr. Straus of National Bank expects ETF investors to continue taking more of a “barbell approach,” which includes loading up portfolios with more niche and active products alongside their cheaper, passive holdings.

He’ll also be watching HISA ETF activity, especially if investors start to pull money out, which could suggest a shift away from safety and toward higher-risk assets.

“That will be a bullish signal. That means people are pulling money from underneath their mattresses to deploy in other places,” Mr. Straus says. “When we see that, I think that will be a sign that sentiment is starting to turn positive for the markets.”

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