The popularity of exchange-traded funds on the Toronto Stock Exchange has reached a once-unthinkable milestone: They now outnumber individual stocks.
A frenzy of product launches catering to every conceivable theme, style sector and country has pushed the total number of ETFs above that of actual operating companies on the TSX. As of the end of January, there were 804 ETFs and other structured products, compared with 786 corporate listings. In January alone, seven providers introduced 25 new ETFs into the Canadian market.
The proliferation of ETFs over the past decade has occurred at the same time as the ranks of listed operating companies have thinned out.
“We have public markets that are more attractive to investors than to companies,” said Bryce Tingle, who holds the Murray Edwards chair of business law at the University of Calgary.
These shifts would have been difficult to fathom 30 years ago, when ETFs were conceived. On March 9, 1990, the world’s first ETF began trading on the TSX, setting the prototype that would ultimately transform how the investing masses access financial markets.
The idea for the Toronto 35 Index Participation Fund, known as TIPs, was to give regular investors access to a diversified basket of equities, with near-zero management fees, in a security that trades just like a stock. TIPs helped spawn a global industry that has now accumulated more than US$6-trillion in assets – a total that doubled in less than four years.
ETFs are listed in 58 countries. Iran has a series of sharia-compliant real estate ETFs. The Hong Kong government created ETFs to sell shares it accumulated during the Asian financial crisis of the late 1990s. And the Bank of Japan uses ETFs in its quantitative easing program, buying up hundreds of billions of dollars’ worth of equity funds to inject liquidity into the financial system.
The ETF seems almost tailor-made for the bull market in stocks, which started more than a decade ago. Ultralow interest rates have pushed investors out of savings vehicles and bonds in search of anything with a decent yield. Heightened awareness around fees has made ETFs an attractive alternative to mutual funds. And the steady drumbeat of record highs has drawn the investing public into the stock market, which is readily accessible through an array of ETFs.
“Anybody can do this now,” said Lorne Steinberg, president of Montreal-based Lorne Steinberg Wealth Management. “The market keeps going up every day and they think, ‘I’ve got to get a piece of it.’ "
The ETF business has evolved way beyond plain-vanilla, broad-market, low-cost equity exposure. Today, investors can readily access sector ETFs, factor ETFs, volatility ETFs, smart beta ETFs and liquid alt ETFs.
“Some of the exotic ETFs are incredibly complex,” Mr. Steinberg said. “They’re difficult for me to understand.” Horizons BetaPro Crude Oil 2x Bull and Bear funds, for example, are designed to double the return of a regular crude ETF. Not only are they highly volatile, both the bull and the bear versions declined in 2016. “How could they both lose money in the same year?” Mr. Steinberg asked.
Critics have long warned the trillions of dollars in passive strategies could distort asset prices, sowing the seeds of the next market crash.
Last September, celebrity investor Michael Burry, who famously anticipated the U.S. subprime mortgage crisis, said he is among those seeing an ETF bubble. “Like most bubbles, the longer it goes on, the worse the crash will be,” Mr. Burry told Bloomberg News.
And yet, the ETF space, while drawing in vast sums of money, controls only a small share of investable assets globally. Most estimates put that number at around 10 per cent, said Robert Duncan, a portfolio manager at Forstrong Global Asset Management. In Canada, ETFs have accumulated assets of $211-billion, as of the end of January, compared with more than $1.6-trillion that still sits in Canadian mutual funds.
In other words, the ETF industry, either globally or in Canada, is nowhere close to the size required to distort the overall stock market, Mr. Duncan said. “The pendulum will probably swing too far into passive at some point,” he said. “Then the market will naturally correct, and people will sell index products and buy active managers.”
One thing the critics have got right, however, is that Canadian investors probably don’t need several hundred ETFs to choose from, Mr. Duncan added.
At the same time, the steady decline of the Canadian pool of corporate listings shows no sign of reversing. Since 2008, the number of stocks on the TSX has dropped by 36 per cent. There are several reasons behind the long-term decline of Canadian corporate listings, including the rise of venture capital and private equity as alternatives to going public, a regulatory burden for public companies that has become more onerous over time, and a wave of takeovers scooping up smaller companies.
“The TSX and the [Ontario Securities Commission] have never acknowledged arresting the decline of listed issuers as a priority,” Mr. Tingle said. “Will this change now that we have passed this milestone?"