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ETFs The rise of ETFs is making life miserable for Canada’s mutual fund industry

Canadian mutual-fund sales will never again outsell Canadian exchange-traded funds in a single year, according to Matt Hougan, chairman of Inside ETFs.

The bold prediction was made last week during the Inside ETFs Canada conference in Montreal, as Mr. Hougan discussed the growth of the Canadian ETF market in comparison with the United States.

Last year, ETFs outsold mutual funds in Canada for the first time in a decade. And nearly halfway through 2019, ETFs are on target to outsell mutual funds again. Already in the first five months, Canadian ETFs have seen net inflows of $10.4-billion in assets, while mutual funds have brought in $4.9-billion, according to data provided by Strategic Insight.

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“Mutual-fund sales were slow to rebound after the market volatility that hit in the final quarter of 2018, and Q1 2019 marked the worst-selling RRSP season for mutual funds in a decade,” said Megan Cobb, an associate consultant at Strategic Insight in Toronto.

In 2018, ETFs had $19.8-billion in net sales, while mutual funds saw essentially negative sales, with $2.7-billion in annual net outflows, according to Strategic Insight.

Mr. Hougan’s prognosis that the mutual-fund boom is ending stems from the success of the ETF market in the United States, particularly in 2009 where investment sales began to pivot toward ETFs. In the past decade, U.S. ETFs have had net sales of US$2.3-trillion, while the U.S. mutual-fund industry has experienced US$92-billion in net redemptions.

That sales trend has both Mr. Hougan, and Dave Nadig, managing director for ETF.com, forecasting that, in terms of assets, the overall U.S. ETF market will surpass that of mutual funds by 2024.

While they do not have a similar prediction for Canada, Mr. Nadig told the audience in Montreal that things “are looking awfully good [in the Canadian market] right now.”

If the United States is a leading indicator at all for Canadian market patterns, then the relative sales trend that began in 2018 could eventually very well match that of the United States, says Daniel Straus, vice-president of ETF research at National Bank of Canada.

Although, he adds, “market forces are a bit different" in the sense that many Canadian investors continue to favour mutual funds. The Canadian ETF industry currently has 35 providers managing approximately $178.6-billion in assets, a sliver of the $1.47-trillion invested in mutual funds.

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“End-of-day NAV [net asset value] trading is still perfectly sufficient for many investors, and if mutual-fund fees come down in response to the competitive pressure coming from ETFs, we might see a stanching of the flow from mutual funds to ETFs,” Mr. Straus says.

Steve Hawkins, president and chief executive of Horizons ETFs Management (Canada) Inc., says he believes ETF sales will remain strong this year and into 2020, but there could be future years where mutual-fund sales will pull ahead again.

“As long as we have the Canadian banks being the primary distributors of investment products – pushing their own mutual funds so easily through branches – the industry will continue to see mutual funds dominate," Mr. Hawkins says.

One major roadblock for the ETF industry – and the banks in particular – is the inability for mutual-fund advisers to sell ETFs. As a result, Canadian banks are not equipped to sell ETFs directly to clients in any of the 6,000 bank branches across the country.

Currently, mutual-fund licensed representatives – including those in a bank branch – are legally licensed to sell ETFs, but the majority of Canada’s mutual-fund dealers do not have direct access to a platform to settle an ETF trade.

Building that access has been a slow-moving project for many firms – and one that is unlikely to happen in any bank channel within the next five years, says Kevin Gopaul, global head of ETFs for BMO Global Asset Management.

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“It’s a tremendous effort to retrain and relicence the branch network as well as the huge technology changes that would have to happen,” says Mr. Gopaul, who oversees the bank’s $55.7-billion ETF business.

The introduction of liquid-alternative mutual funds in the retail space is another factor to consider when looking at the future of ETFs and mutual funds in the Canadian marketplace, Mr. Gopaul says.

Liquid-alternative funds – also referred to as liquid alts – are typically hedge fund or private-equity strategies made available through a mutual-fund account.

“Liquid alternatives are going to revitalize the mutual fund industry,” he said in an interview. “As well, for many people, mutual funds are easier to trade, they come with no discussion about liquidity or trading commissions, there is no bid-ask spread to consider."

Side bar: The last decade of ETFs

Exchange-traded funds in Canada has seen steady growth over the last 10 years with assets under management now just under $180-billion, up from $32-billion in 2009, according to data provided by National Bank Financial.

In addition, the last decade has seen a substantial number of Canadian ETF providers come to market - with 36 firms operating today. That is up from the traditional four firms who were operating in 2009: Blackrock Inc., Claymore Investments, Horizons ETFs Management (Canada) Inc. and BMO Global Asset Management.

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“The industry has seen tremendous progress over the last decade, prompting innovative investment products and tools,” said Kristi Mitchem, chief executive of BMO Global Asset Management, in an ETF report released Monday to mark the 10 years’ progress since the bank’s entrance into the market. “As the popularity of ETFs accelerates in Canada and across global markets, there is a greater need for education and support to maximize portfolio efficiency.”

Several significant changes noted by BMO over the last decade in the ETF industry include:

  • Changes in distribution: The last decade has seen the rise of robo-advisers and other model platforms, as well as a shift in adviser activity toward fee-based investing. These platforms predominately use ETFs for market exposures and low-cost portfolios. Currently the robo-adviser industry holds more than $7-billion in assets and has “an anticipated annual growth rate of 35 per cent," according to a BMO ETF progress report.
  • Fees and CRM2: The biggest regulatory initiative over the past decade was CRM2, or the second phase of the client relationship model – which prompted the industry to further clarity the way investments and fees appear on an investor’s annual statement from financial institutions. With prices under the microscope, ETFs (which do not include embedded commissions for advice) began to be used more often in portfolios.
  • Adding new exposures: The industry recognized the importance of growth in over-the-counter (OTC) exposures early on, seeing it as an opportunity to help investors build and adjust portfolios with efficient, low-cost ETFs across a range of asset classes, from gold to listed infrastructure to fixed income.
  • Asset allocation ETFs: Vanguard Group was the first in Canada to provides investors with various mixes of stocks and bonds in a single fund that automatically rebalances with a low-cost annual management fees. Earlier this year, BMO Global Asset Management was the latest to begin trading asset allocation funds – often referred to as a “one-ticket” solution for investors.
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