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ETFs How a big deal in the ETF industry could mean better returns and lower fees for investors

Anything that puts more exchange-traded funds in the hands of investors instead of junk mutual funds and sketchy or poorly chosen stocks is a win.

That’s what the partnership announced earlier this week between ETF leader BlackRock Inc. and ETF laggard Royal Bank of Canada will do. ETFs have surged in popularity in recent years, but they’re still just a sliver of what the mutual fund industry has amassed. Getting the investment industry to use ETFs at the expense of other products is the best path forward for future growth.

RBC came late to ETFs and hasn’t made much of a dent. What it offers to the partnership is its vast operations as a big bank. RBC’s in-house family of index mutual funds will be cleared to hold BlackRock’s iShares ETFs instead of individual stocks, and RBC’s advisers, planners and brokers will be encouraged to employ ETFs where previously they used other things.

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Let’s acknowledge that there are some smart advisers out there generating all the returns their clients need to meet their financial goals using stocks, mutual funds and in-house fund products. But stock-picking is a rare skill and it’s still harder to be successful on a consistent long-term basis. Quality mutual funds exist, but it’s amazing how much money rots away in overpriced, sub-par funds.

ETFs would be an improvement for many investors. They’d pay less overall in fees and get better returns.

Not just any ETFs, mind you. The ones that provide the sturdiest foundation are the ultra-cheap ETFs that track the popular stock and bond indexes we use as a gauge of performance for stocks and bonds. It happens that the iShares franchise is a big player in this type of ETF, along with BMO ETFs, Vanguard and, to some extent, Horizons.

As my colleague Clare O’Hara reported a few days ago, for the first 11 months of 2018, ETF sales actually beat mutual fund sales, which were at their lowest point in more than a decade. But ETF assets are still just about $157-billion, compared with $1.5-trillion in mutual funds.

Cheap index-tracking ETFs powered most of the growth in ETFs so far, but there’s a sense in the industry that these products aren’t enough to really challenge mutual funds. One solution has been to offer more complex, pricier ETFs that use strategies where the stocks in a particular index are filtered for certain attributes, such as strong profit and revenue growth or dividend growth and sustainability.

The natural extension of this strategy is to exploit trends and themes like the legalization of cannabis, artificial intelligence, cyber-security and more. All these non-traditional funds have broadened the appeal of ETFs, but they have also cluttered the sector with products that are utterly beside the point if you’re investing for retirement or your children’s university education.

The RBC-BlackRock partnership is a welcome sign that the ETF business won’t base its next leg of growth on more flaky funds. Now, it’s more about trying to get more people to use ETFs instead of the alternatives.

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DIY investors are already true believers in ETFs. Advisers, not so much. If you want to understand the powerful role advisers have in the success of an investment product, look to the trillions sitting in North American mutual funds. Most of that money is overseen by an adviser.

You can see what happens when a motivated bank gets into the ETF business by looking at Bank of Montreal. BMO has, over the past 10 years or so, become an ETF powerhouse by producing competitive products and getting them used internally. BMO continues to increase its assets and poses the biggest threat to overtake the market leader, BlackRock’s iShares lineup.

It’s not that ETFs are necessarily the best investment out there. In any given period of a year or two, there will be stocks and mutual funds that crush their returns. Investors and advisers who use ETFs understand and embrace that. They know that cheap, index-tracking ETFs will outperform most funds and stock-pickers over the long term, which is to say they’re a foundation of successful investing. That’s why any deal that expands the reach of ETFs is good deal.

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