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An attractive quality of ETFs-based mutual funds is that the management fees are similar to those of their ETFs counterparts.

blackwaterimages/iStockPhoto / Getty Images

Mutual funds that contain one or more exchange-traded funds (ETFs) are becoming more popular among financial advisors and their clients, many of whom are increasingly looking to take advantage of the investing strategies and lower fees that ETFs offer.

Since the beginning of 2018, approximately 34 such mutual funds have launched, bringing the total in Canada to more than 85. And these launches have come despite recent changes that allow advisors with a mutual fund licence to obtain the necessary proficiency standards to buy and sell ETFs for their clients.

From mutual fund portfolios of ETFs offered by BlackRock Asset Management Canada Ltd., Franklin Templeton Investments Corp. and Vanguard Investments Canada Inc., to mutual funds that include a single ETF, advisors have a growing number of options available for their clients.

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Among the new entrants are 15 mutual funds from Fidelity Investments Canada ULC that have launched since September 2018. Fourteen of these contain only one ETF per mutual fund. One contains a variety of the ETFs.

Andrew Clee, vice-president, ETFs, at Fidelity, says there has been strong demand so far for the asset-management firm’s ETF-based mutual fund offerings, which were unveiled simultaneously with their counterpart ETFs.

“To date, we have [attracted] about $360-million [in assets for both the mutual funds and ETFs],” he says, “[and] about 28 per cent of that has come from the mutual funds.”

Mr. Clee notes that these products – essentially smart beta ETFs in a mutual fund wrapper – have wide appeal because of the many mutual fund investors who are seeking ETFs-style products.

Indeed, recent data from the Investment Fund Institute of Canada (IFIC) reveal that ETFs in mutual fund wrapper have built up a sizable niche, accounting for almost $11-billion in assets under management (AUM) at year-end 2018, up from about $10.7-billion a year prior. Although this is just a sliver of the $1.51-trillion in AUM for all mutual funds in Canada as of Feb. 28, IFIC data also show that the $169-billion in ETFs AUM is growing at a faster pace than the mutual funds AUM (at 3 per cent versus 2.3 per cent in February, respectively, month-over-month).

ETFs in a mutual fund wrapper represent a middle ground. For decades, the investment funds industry had focused mostly on generating actively managed mutual fund sales. More recently, it has faced growing demand for ETFs from millions of investors working with the approximately 80,000 advisors who are licensed by the Mutual Fund Dealers Association of Canada (MFDA).

The existence and growth of ETFs in a mutual fund wrapper are due, in part, to the fact most MFDA-licensed advisors cannot offer direct access to ETFs, says Michael Schnitman, senior vice-president of product at Mackenzie Investments.

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“That’s why MFDA[-licensed] advisors love them,” he says, “because they offer access to the features of ETFs in a mutual fund [structure].”

In 2017, the MFDA introduced rules to allow mutual fund-licensed advisors to obtain proficiency requirements to sell ETFs. Prior to that, only advisors licensed by the Investment Industry Regulatory Organization of Canada could trade ETFs for clients.

Despite these changes, ETFs in a mutual fund wrapper are still gaining traction as few MFDA-licensed advisors have gone ahead with the training necessary to sell ETFs, Mr. Clee says.

“It’s not that the education component is a barrier,” he explains, “it has more [to do with] the whole operational framework [for MFDA-licensed firms] to buy and sell [ETFs].”

Specifically, many MFDA-licensed firms and their advisors have not built out the access to their platforms necessary to settle ETFs trades for clients – and building that capability involves extensive compliance and technology challenges, both of which require significant investments of time and money.

That’s a key reason why Mackenzie Investments has seen strong demand for its new ETFs-based mutual funds, which launched in early 2018 and are “one-ticket [ETF] solutions in a mutual fund package,” Mr. Schnitman says, that contain a “full spectrum of passive, active and vector [smart beta] strategies.”

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Another key driver for these products is their ease of use, which have also made them popular with IIROC-licensed advisors, says Chris Doll, vice-president of ETF sales and strategy at Invesco Canada Ltd.

Invesco Canada, the first company in this country to offer mutual funds containing ETFs, first “thought it would be predominantly [MFDA-licensed] advisors buying these products, but in reality, it turned out to be about a 50-50 split.”

He adds that Invesco Canada launched its ETFs-based mutual funds in 2009 not out of demand, but as a workaround to not being able to find a market-maker in Canada at that time to trade its ETFs lineup, which Atlanta-based parent firm Invesco Ltd. acquired along with PowerShares Capital Management LLC in 2006.

Invesco Canada’s mutual funds of ETFs caught on with IIROC-licensed advisors not only because they were attracted to the underlying ETFs, but because many also liked the characteristics of the mutual fund structure, which is particularly well-suited for pre-authorized contributions, Mr. Doll says. These mutual funds were a good fit for clients with smaller accounts who wanted ETFs, but whose contributions were too small for efficient ETFs trading.

Another attractive quality is that the management fees for ETFs-based mutual funds are similar to their ETFs counterparts. Although the mutual fund versions do come with an additional administrative fee of about 15 basis points, the investment vehicles are closely priced after accounting for the cost of the bid-ask spread cost when trading an ETF, Mr. Clee notes. He adds that Series A mutual funds, which include a trailer fee, are more pricey, but the ETFs-based mutual funds are geared more toward the fast-growing demand for lower-priced Series F mutual funds for fee-only advisors.

“That’s because the growth of the fee-based financial advisory business has been exponential in the past few years,” Mr. Schnitman says. “So, the advisor is either selecting Series F mutual funds or ETFs. Of course, the problem for many MFDA[-licensed] advisors is they can’t buy ETFs, so they’re using Series F [mutual funds].”

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Mr. Doll adds that this is one reason Invesco Canada forecasts the market for ETFs in a mutual fund wrapper will continue to expand. To date, these mutual funds account for about 15 per cent of Invesco Canada’s $10-billion ETF business in Canada. The firm’s actively managed mutual fund business is still king, with about $30-billion in AUM.

But as demand for ETFs continues to grow faster than for actively managed mutual funds, the market for ETFs in a mutual fund wrapper is expected to expand along with it, Mr. Doll says.

“Otherwise, you wouldn’t see asset managers launching products [at a greater pace] in the past year,” he says, “even though the concept has been around for more than 10 years.”

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