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Canadian investors and financial advisers are shifting away from traditional mutual funds as they pour more money into exchange-traded funds, with ETFs set to outpace mutual funds sales for the first time in a decade.

With $18.7-billion in net sales, ETFs in the first 11 months of 2018 heavily outsold mutual fund investments, according to data provided by Strategic Insight. Mutual funds produced the lowest sales total in more than a decade, at $7.8-billion.

The decline in sales volume for mutual funds was driven by stand-alone funds, says Megan Cobb, senior analyst with Strategic Insight; these funds, which focus on a single asset class such as Canadian equities or bonds, saw net redemptions of $16.2-billion throughout the first eleven months of 2018, the highest record of mutual fund outflows to date.

The shift comes after five years of dominant mutual fund sales where some years saw investors put more than three times the amount of money into mutual funds versus ETFs.

“While ETF sales are down year-over-year, mutual funds are being impacted more severely by a number of external factors,” Ms. Cobb said in an interview. “Rising interest rates are having a significant and negative effect on fixed-income mutual funds and market volatility is doing little to support domestic equity funds."

In addition, Ms. Cobb notes, yields are also increasing on deposit products, positioning guaranteed investment certificates as a competitive alternative to mutual funds.

The Canadian ETF industry currently has 33 providers managing approximately $156.6-billion in assets; a sliver of the $1.5-trillion sitting in the mutual fund industry. Yet, despite being only 10 per cent of the overall market, 2019 will be a pivotal year for ETFs. For the first time, all the major Canadian banks will be in the ETF market selling in-house ETF products – although their ETF channels may not catch on as quickly as mutual funds did in the 1990s.

“As long as we have the Canadian banks being the primary distributors of investment products and selling their own mutual funds so easily through branches, it is going to take a while for ETF growth in Canada to really take off,” says Steve Hawkins, president and CEO of Horizons ETFs Management (Canada) Inc. "Now, investors here, like in the U.S., are starting to wake up to the notion of using ETFs to get quick tactical allocation to certain asset classes and sectors, and using those ETFs to reallocate their asset allocation throughout the year to generate [returns]. That is the way that ETFs are going to be used.”

This pivot toward ETFs, while relatively recent in Canada, is already well established in the United States, where ETFs have been outselling mutual funds each year since 2013. In 2017, U.S. ETFs saw US$464-billion in sales compared with only US$174-billion going into mutual fund products.

“After the financial crisis in 2008-09, U.S. investors woke up to a new world of cost-consciousness,” says Daniel Straus, a research analyst with National Bank Financial. “Scarred by losses and expecting low future returns, we think that many investors came to the realization that controlling cost is a big part of successful outcomes.”

Mr. Straus notes the financial crisis was a shock to the system that really signified a change in investor behaviour in the United States, but it has been a slower transition in the Canadian market.

Jeff Weniger, asset allocation strategist for WisdomTree Canada, says that as recently as 2014, many of today’s ETF players had not yet entered the market, making for narrower choice. Now with more than 10 providers entering in the last two years, “product innovation has heightened and will likely continue into 2019 as investors increasingly demand low-cost investment options.”

While more players bring more choice, Mr. Hawkins believes there will be some consolidation within the industry, specifically within the top 10 providers. As well, he notes, investors will see more socially responsible investing funds emerge as retail clients begin to pay closer attention to the stocks they are investing in from an environmental, social and governance perspective.

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