As anyone who has ever been stumped by 31 flavors of ice cream can attest, there is no shortage of choices in today’s world. Marketers routinely resort to brand extensions and gimmickry in an effort to boost sales and market share.
But is having more choice better when it comes to buying a box of cereal or bottle of wine when there's that nagging feeling there might have been something cheaper or better on the shelf?
This sums up the state of ETF investing today, as providers offer even more sophisticated and exotic funds to gain a larger slice of Canadians’ investments.
All that choice might fatten up financial firms’ bottom lines but not necessarily improve people’s portfolios, based on a theory dubbed the “paradox of choice.”
To put it simply: give buyers too many options, and chances are greater they’ll be overwhelmed and unable to make a selection, as U.S. psychologists found in a study of consumer behaviour. The researchers found that customers bought more jam when they had six options in front of them than when they had 24 to choose from.
“I wish it was the truth that most investors just want to keep things simple, because the opportunity is there to keep things simple,” says Dan Bortolotti, a portfolio manager with PWL Capital Inc. in Toronto. “But most investors, I think, naturally resist simplicity.”
Even as ETF providers have rushed to bring out new and different funds, Mr. Bortolotti says they did give a nod to simplicity by rolling out all-in-one, fund-of-fund ETFs that eliminate the paralysis or disappointment that can come with having too many options.
“Obviously, for the vast majority of people, just choosing one of these ETFs and just using nothing but that is going to be a lot better than what they are doing,” Mr. Bortolotti says. “But you would be surprised by the number of people that I correspond with who figure `It can’t be that simple. I have to build a portfolio of five or six ETFs.’”
A never-ending list of ETF options
Meanwhile, the pace of new fund launches continues to grow. There were 848 ETFs offered by 38 providers with a total value of $183.7-billion in Canada as of July 31, according to National Bank of Canada’s ETF Research Group. That’s up from 720 ETFs from 28 providers with a value of $160-billion from a year earlier.
One trend is that the fees charged to investors continue to fall over time as the biggest providers gain additional capital and can trim costs.
While low cost remains the key selling attribute for ETFs, the industry has expanded into actively managed funds and specific strategies aimed at sophisticated investors. Last month, nine ETFs launched, and seven of those were multi-asset funds “with asset allocation, covered call or defined payoff mandates,” National Bank said in a recent note.
Smaller ETF entrants, which are at a distinct disadvantage in a market dominated by a handful of large firms, are innovators by necessity.
In July, Emerge Canada Inc. introduced five actively managed ETFs on the NEO Exchange in sectors such as genomics, biotech, artificial intelligence and robotics. As well, hedge fund manager Picton Mahoney Asset Management launched ETF units for its Fortified Alternative Fund group that invest in long and short equity positions, derivatives, fixed-income securities and other instruments.
Too many funds can add unnecessary complications, Mr. Bortolotti says, as well as introduce more risk in what should be, by definition, a low-risk strategy.
“What you sacrifice there is simplicity, and you add all kinds of opportunity to make mistakes, which are likely to be a lot more costly,” he says.
Beware the ‘paralysis of analysis’
The profusion of funds “has gotten a bit ridiculous,” says Yves Rebetez, an ETF consultant with Credo Consulting Inc. of Mississauga, Ont. He worries “paralysis of analysis” can strike investors focused on the latest, greatest fund introductions.
“People need to ensure that they do not lose sight of what are some of the greatest benefits of ETFs,” Mr. Rebetez says, instead of worrying about chasing hot or emerging industries such as cannabis.
ETFs literally offer the world and can eliminate any regret that comes with too many choices.
“For Canadians that have this crazy home bias [in their portfolios], to be able to actually grab one ETF and be able to grab the world, that is pretty good,” Mr. Rebetez says.
Canadian investment portfolios are literally stuffed with domestic stocks and bonds, he says, which is inherently a bad strategy when our market comprises a tiny fraction of world stock and bond markets.
ETFs offer a simple and cost-effective way out of that Canada trap.
“The key to ETFs in terms of their main benefit is the ability to beat the vast majority of active managers over any time horizon … while giving you incredible access in terms of diversification,” Mr. Rebetez says. “Add to that, the costs are low, they are tax efficient and highly liquid as well.”
Advisers can also be tempted by too much choice
Even investment professionals have to guard against the temptation to add the complexity and possibly higher costs that come with the ongoing ETF product evolution.
“Part of the problem with the paradox of choice is that if you want to do proper due diligence, there is no way any reputable human being can actually know the bells and whistles and pros of cons of that many products,” says John De Goey, a portfolio manager with Wellington-Altus Private Wealth in Toronto and author of the recently released book STANDUP to the Financial Services Industry: A Practical Guide For Canadians.
Mr. De Goey relies on a modest five or six core ETFs that he regularly includes in his clients’ portfolios and swaps out one or two from that mix annually when funds that offer better value or market coverage are introduced.
Over the years, Mr. De Goey has found chasing complexity carries a cost. Fund providers “make a big deal out of small differences” that make little to no impact on his goal to ensure clients reach their retirement goals.
“If you are client-focused, a lot of those sort of considerations fall by the wayside,” he says. “It’s the advisers that are product-focused that tend to get caught up in those weeds.”