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FOR FINANCIAL ADVISORS • 2 019

As new funds emerge, how do you choose what’s right for your client?

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Investing. Do it different. manulifeinvestments.ca/different Long-term growth represents index performance histories of S&P 500 Index TR USD (large caps), 6.1%; Russell Mid Cap Index TR USD (mid caps), 9.2%; and Russell 2000 Index TR USD (small caps), 8.0% from 7/31/1999-7/31/2019. Risk-adjusted returns measured as Sharpe Ratio. S&P 500 Index TR USD (large caps), 0.31; Russell Mid Cap Index TR USD (mid caps), 0.45; and Russell 2000 Index TR USD (small caps), 0.35 from 7/31/1999-7/31/2019. Source: Morningstar Direct as of July 31, 2019. © 2019 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Commissions, management fees and expenses all may be associated with exchange traded funds (ETFs). Investment objectives, risks, fees, expenses and other important information are contained in the ETF facts as well as the prospectus, please read before investing. ETFs are not guaranteed, their values change frequently and past performance may not be repeated. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license. MP1091711E

08/19

Presented by

INVESTMENT EXECUTIVE

PRESIDENT, TC MEDIA PIERRE MARCOUX GROUP PUBLISHER, INVESTMENT & ADVISOR GROUPS STEFANIE MacDONALD EDITORIAL DIRECTOR MELISSA SHIN

CONTENTS PRODUCTS 4

By Rudy Luukko

SENIOR EDITOR GREG DALGETTY

RESEARCH & SPECIAL PROJECTS EDITOR KATIE KEIR PROOFREADER CHARISE ARSCOTT ART DIRECTOR, INVESTMENT GROUP GIL MARTINEZ DIRECTOR OF CLIENT STRATEGY JULIA SOKOLOVA DIRECTOR OF CONTENT SOLUTIONS ANNA-CHRISTINA DI LIBERTO ADVERTISING SALES JACKIE KIVI, KATHY LIOTTA, IRENE PICANCO, VIVIAN TSE

TAKING CONTROL While passive ETFs account for the bulk of AUM, active products are moving up.

MANAGING EDITOR GRANT McINTYRE

RESEARCH EDITOR FIONA COLLIE (ON LEAVE)

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2019 ETF GUIDE

SMOOTHING THE BUMPS

STRATEGIES

There are several ways to reduce downside risk in an ETF portfolio.

18 BUILDING BLOCKS Two advisors weigh in on balanced ETFs and construct model ETF portfolios.

By Dwarka Lakhan

10 TAKING ON THE GIANTS

By Greg Dalgetty

As the ETF industry grows, big players get bigger and small firms face barriers.

22 LOOKING ABROAD Investing in foreign equity ETFs could trigger withholding taxes for your clients.

By Mark Burgess

14 MYTH-BUSTING

By Rudy Mezzetta

Clearing up some of the misconceptions clients may have about ETFs.

OPINION

By Michelle Schriver

24 TELL YOUR STORY WELL Communicate clearly with your clients to ensure they understand your ETF strategy.

CHRIS TURNER / GET T Y IMAGES. COVER : MAGNILION / ISTOCKPHOTO

By Mary Hagerman

PEOPLE 26 THE LAY OF THE LAND National Bank’s Daniel Straus considers the future of the ETF industry. By Patricia Chisholm

29 A VISION FOR TOMORROW Charles Schwab’s Shanna Weber would like to see more women in senior roles. By Patricia Chisholm

Investment Executive’s ETF Guide 2019

While passively managed funds still account for the bulk of Canada’s ETF assets, active ETFs are on an upward trajectory By Rudy Luukko

n the ever-expanding Canadian ETF universe, actively managed strategies are a growing presence in what was originally the exclusive preserve of passive indexing. At the end of Q1 2019, according to data compiled by New York-based Strategic Insight Inc., 263 of 701 Canadian-listed ETFs were actively managed. That’s almost four in every 10. The proliferation of active ETFs has taken place across the board, from leading companies, to newer entrants among multibillion-dollar asset-management companies, to boutique firms. Active mandates encompass the full spectrum of asset classes, from core equity and fixed-income categories to specialty products investing in specific sectors or pursuing alternative strategies. Asset growth, however, has been less dramatic. Active ETFs accounted for only 21% of the $172.9 billion in ETF assets under management as of March 31. According to the Canadian ETF Association, only two among the 20 largest ETFs were actively managed as of the end of May. Given this relatively modest market penetration, there remains scope for expansion. “The active suite of products we have today — it’s not the final chapter,” says Mark Neill, head of ETFs for RBC Global Asset Management Inc. (RBCGAM). RBCGAM and market-share leader BlackRock Asset Management Canada Ltd. are co-operating in marketing and product launches through their strategic alliance. (Both firms are based in Toronto.) While the bulk of BlackRock’s iShares ETFs are passively managed, the firm also offers rules-based active strategies and the fully active Dynamic iShares ETFs, the latter of which are based on mutual funds managed by Toronto-based 1832 Asset Management LP. RBCGAM, for its part, is expanding its ETF suite beyond its current lineup of actively managed fixed-income and RBC Quant rules-based equity ETFs. “RBCGAM will absolutely be wholly focused on building out that active side of the product shelf,” Neill says. “We’re taking a methodical, consultative approach to what we’ve put to the marketplace, to make sure that every product we launch can add value, can solve problems and, hopefully, is innovative and helpful to the marketplace.” Actively managed ETFs fall into one of several types. There’s strategic beta, which is non-passive indexing that employs criteria other than market capitalization or equal weighting. One of the oldest of this genre is iShares Canadian Fundamental Index ETF, launched in February 2006 as part of the

I nvestment Executive’s ETF Guide 2019

ETF family formerly under the Claymore brand. That ETF’s stock weightings are based on factors such as cash dividends, free cash flow and total sales. Other examples include the Mackenzie Maximum Diversification suite of ETFs, managed by Paris-based TOBAM on behalf of Mackenzie Financial Corp.; Fidelity Investments Canada ULC’s dividend-focused ETFs; CI Investments Inc.’s First Asset ETFs that track strategic beta Morningstar Inc. and MSCI Inc. indices; and Franklin Templeton Investments Corp.’s LibertyQT suite. (All these ETF manufacturers are based in Toronto.) Some active strategies are rules-based and quantitative, but not linked to an index. That description applies to most of Toronto-based Purpose Investments Inc.’s equities lineup, in which the word “index” is conspicuously absent from ETF names. Purpose International Dividend Fund, for example, is actively managed, but employs equal weightings, a 20% sector cap and rankings for stable dividend yields and value factors. “We’re not going to be constrained by the index concept,” says Som Seif, Purpose’s president and CEO. “Rather, we’re going to focus on [doing] that really well, but also implementing risk-management policies and procedures across everything we do.” Other examples of factor-driven non-index strategies include AGF Investments Inc.’s lineup of 10 AGFiQ ETFs and Vanguard Investments Canada Inc.’s four global ETFs. The Vanguard ETFs screen for liquidity, minimum volatility, momentum or value. (Both firms are based in Toronto.) Elsewhere, active ETFs that employ covered-call option writing also have elements of passive investing. These ETFs typically hold equally weighted stock portfolios that are rebalanced periodically, although Toronto-based BMO Asset Management Inc. also offers some ETFs with holdings weighted according to dividend yields. Other notable providers of covered-call ETFs are CI, Oakville, Ont.-based Harvest Portfolios Group Inc. and Toronto-based Horizons ETFs Management (Canada) Inc. The purest forms of active ETF portfolio management, and the ones closest to traditional mutual funds, are those with fully discretionary investment mandates. These types of active mandates have the greatest potential for expansion in ETF lineups by companies that can either draw on their in-house investment teams or hire subadvisors. Fully active management is entrenched in the fixed-income categories, for which demand has been fuelled by the “substitution effect.” 6

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PRODUCTS

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strategy and development at the firm. Sometimes, she adds, “people want very sharp tools, and more granular splits of certain asset classes,” which is less true in the mutual fund world. Bhandal leaves the door open to Invesco ETFs expanding into the traditional bottom-up stock-picking strategies of its equity mutual funds. “We’re always evaluating and trying to determine what clients want, and what vehicles they want it in, because, frankly, we’re vehicle-agnostic. If clients want [an investment strategy] in an ETF, we’ll create it in an ETF.” At AGF, meanwhile, there’s no overlap between its mutual fund and ETF lineups, even though some of its investment personnel manage both product types. “Within the ETF space, a lot of the times it is the advisor looking for clean building blocks to create portfolios, models and strategies that they can rebalance on their own, based on their own beliefs and biases,” says Florence Narine, senior vice president, product. “We are always revisiting the decision whether or not our existing fundamental strategies within the mutual fund wrapper make sense within an ETF vehicle. But we took the approach of [asking], ‘What is that advisor and client aiming to do with an ETF?’” Narine cites the Canadian Securities Administrators’ client-focused reforms as creating an advantage of maintaining distinct product lines between ETFs and mutual funds. Doing so, she says, creates clarity for advisors, who don’t have to decide between pricing and other differences between the two structures. One of the trends noted in the ETF Report, published in June by BMO Asset Management Ltd. (operating as BMO Global Asset Management [BMOGAM]), is the use of active management in less efficient markets. This has proven to be the case for ETFs specializing in the cannabis industry, with active ETFs managed by Purpose and Toronto-based Evolve Funds Group Inc. outperforming the sector as a whole. “With so much volatility in that market [and] so many developments taking place from a rules and regulations and government policy perspectives, we felt that was also [an industry] that merited active management,” says Raj Lala, Evolve’s president and CEO. But ETF providers must be mindful of the challenges posed by intraday trading in less efficient markets. “What’s most important when you put a mandate in an ETF wrapper is thinking about that exchange experience, and making sure the liquidity is there and the underlying spreads are going to be at a reasonable level,” says Mark Raes, managing director and head of product with BMOGAM. Holdings disclosure also may be an issue for some active portfolio managers, but perhaps less so than before. “By and large, the market has overcome that, and true active ETFs that have come out have been successful,” Raes says. It helps that disclosure rules for Canadian ETFs are the same as for mutual funds and daily disclosure of ETF holdings isn’t mandatory. Recent BMOGAM ETF launches include fully active Canadian equity and North American equity funds, subadvised by Calgary-based SIA Wealth Management Inc. Active ETFs are “another opportunity to distribute our product, and it aligns very well with what advisors and portfolio managers are doing, which is building more ticker-based business into their books,” says Raes. “We want to be right there and walk hand in hand with that.” •

4 Financial advisors are increasingly placing bond ETFs in clients’ portfolios rather than investing directly in bonds, for which bid/ask spreads may be wide and inventories scarce for retail accounts. Among the most extensive lineups of active fixed-income ETFs is that of Horizons, which the company began building in 2009. “We saw all of these inefficiencies in the fixed-income marketplace,” says Steve Hawkins, president and CEO, adding that there were “a lot of opportunities for active fixed-income to outperform traditional benchmark fixed-income.” Lacking the necessary internal investment expertise, Horizons hired Fiera Capital Corp. as subadvisor to manage Horizons’ bond and preferred share ETFs and AlphaFixe Inc. to manage its senior loans ETF. (Both Fiera and AlphaFixe are based in Montreal.) The bank-owned and independent providers that manage traditional mutual funds can leverage their internal investment capabilities for their active fixed-income ETFs. Bank of Montreal and Royal Bank of Canada both are well represented in the active fixed-income space, while Toronto-based CIBC Asset Management Inc. launched a pair of active bond strategies when it entered the ETF market in January. Among the independents, Mackenzie’s active fixed-income ETFs are managed by the same internal team that manages the firm’s mutual funds. Similarly, Franklin Templeton draws on internal portfolio managers in Calgary and from its affiliated portfolio managers in California. First Asset Management Inc. has capitalized on being taken over by CI Financial Corp. in 2015. This facilitated the launch of more First Asset fixedincome ETFs, which are managed by either Signature Global Asset Management or Marret Asset Management Inc. (both fellow subsidiaries of CI). “If you look at the number of portfolio-management groups within CI, [they] really allowed us to expand on that part of our ETF lineup with a lot more ease than had CI never acquired us,” says Peter Tomiuk, senior vice president, ETF strategy, on CI First Asset’s sales team. Far less of a presence throughout the industry are the fully active equity mandates that have been mainstays of mutual fund sponsors. The large actively managed core equity mandates that CI’s Signature team manages have no ETF equivalents at CI First Asset. “It’s not to say we wouldn’t expand more on our equity side on the full discretionary active side,” says Tomiuk. “But without a doubt, I think we were able to, a couple of years ago and even now, identify more of a need on the active fixed-income side.” He adds that there will be “a real appetite” for some of the active CI equity strategies that currently aren’t available in ETF form. Rules-based equity mandates, rather than fully discretionary ones, are the approach taken by Toronto-based Invesco Canada Ltd. since it began offering ETFs in 2011. ETF and mutual fund portfolio managers don’t always have the same needs, says Jasmit Bhandal, vice president and head of ETF product

I nvestment Executive’s ETF Guide 2019

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Taming volatility 123RF STOCK PHOTO

There are several ways to reduce downside risk in an ETF portfolio By Dwarka Lakhan

hen securities markets turn volatile — as they have been since the fourth quarter of 2018 — ETF investors tend to flock toward products that can mitigate that volatility and reduce equities’ risk. These products may include low-volatility ETFs, hedge fund ETFs and buffer ETFs. Low-volatility ETFs, which employ investment strategies designed to reduce downside risk during periods of market volatility, are the traditional choice. “The key promise of these ETFs is to protect [portfolio] value when the markets are going down,” says Chris Heakes, director and portfolio manager, ETFs, with BMO Asset Management Inc. in Toronto. “Investors still get upside exposure to equities, but also get downside protection when the markets turn negative.” Adds David Kletz, vice president and portfolio manager with Forstrong Global Asset Management Inc. in Toronto: “[Low-volatility] ETFs should suffer less extreme losses than the broad market during a downturn.” But you and your clients should learn about the benefits and limitations of low-volatility ETFs before including them in portfolios. “The biggest risk with these [ETFs] is that investors do not understand how they work and what they are meant to do, especially when it comes to return expectations,” says Mark Noble, senior vice president, ETF strategy, with Horizons ETFs Management (Canada) Inc. Typically, low-volatility ETFs use an indexmirroring methodology in which the chosen stocks that have exhibited lower volatility have higher weights in the mirror index, says Noble. Other solutions include “actively managed ETFs that have a lower volatility than the broader equities market; that incorporate strategies that have a heavy focus on risk management.” Pure strategies, which incorporate active risk-management metrics, tend to offer a higher degree of protection than index-based strategies, Heakes says. “We use low beta as a metric to determine which stocks should be held in a portfolio,” he says. “We do not start with the index and decide to look like the index.” There aren’t any constraints on the selection of low-beta stocks across sectors, Heakes adds, with the exception that concentration risk in any given sector is avoided. Comparatively, index-based strategies tend to replicate the sector weights in the pertinent index. The ETF’s portfolio manager may choose to hold, for example, plus or minus 5% of a sector weighting as part of a low-volatility strategy — consequently, the ETF would end up looking a lot like the index. Paul Vendrinsky, portfolio manager with SIA Wealth Management Inc. in Calgary, says his firm’s approach to mitigating volatility involves “implementing unconstrained and tactical investment strategies based on relative strength analysis. These strategies are designed to mitigate longterm downside volatility, especially during negative equities markets.” Regardless of the tactics used, lower-volatility strategies generated better returns overall than the broader equities market did during recent periods of heightened volatility, Noble says, beginning late in 2018

and through most of the first six months of 2019. “From the beginning of the fourth quarter of 2018 [and] up to the end of June 2019, the S&P 500 [composite] index had a total return of about 1.52%, whereas one of the most widely followed low-volatility equity ETFs, iShares Edge Minimum Volatility USA ETF [TSX: USMV], was up by 7.61%,” Noble says. “In Canada, we see a similar pattern with the S&P/TSX composite index, which was up by 1.69% [over the same period], whereas BMO Low Volatility Canadian Equity ETF [TSX: ZLB] was up by 11.2%.” The biggest issue with low-volatility ETFs is that they do well during periods of relatively high volatility, but can underperform in a growth market or a rising interest rate market, Noble says. For example, in 2016, the Canadian equities market was up by 15.4% for the year, while ZLB was up by only 9.97%. Hedge fund ETFs, such as Horizons Seasonal Rotation ETF (TSX: HAC) and Purpose Multi-Strategy Market Neutral ETF (TSX: PMM) also focus on providing absolute returns, regardless of whether the markets rise or drop. “HAC has the ability to invest in cash or defensive assets, such as gold,” Noble says, “and can generate excess returns in a market pullback.” HAC has delivered a five-year annualized return of 8.51% as of Aug. 23, 2019. Buffer ETFs represent a new risk-mitigating strategy. These ETFs, offered by Wheaton, Ill.based Innovator Capital Management LLC and Toronto-based FT Portfolios Canada Co., use options strategies to limit losses. At Innovator, the buffer is based on the level of the S&P 500 on the day the ETF launched, so if you buy a buffer fund when stocks have dipped below the starting level, you will enjoy less downside protection. However, you would not see any gains until stocks rebound to above the starting threshold. Hedge fund and buffer ETFs funds have higher fees than regular ETFs, Noble says: “Most plain-vanilla market cap-weighted [ETFs] have management fees of less than 20 basis points (bps), whereas most factor or alternative ETFs have management fees of roughly 35 bps to almost 1%.” Noble attributes the higher cost to the greater complexity in structuring these ETFs. Costs may also include higher trading fees, the cost of derivative contracts and, in some cases, performance fees. “Alternative investment strategies that employ shorting or leverage would be expected to have a higher risk associated with them,” Noble adds. Using low-volatility ETFs makes sense toward the end of the business cycle, Kletz says, as the risk/return profile of the broad equities market begins to skew to the downside. “Conversely,” he says, “a higher-beta approach is warranted as the business cycle begins to stabilize following a recession because the early phase of an economic recovery typically produces a sharp rally for stock markets, with more volatile companies being the primary beneficiaries.” Vendrinsky cautions that low-volatility ETFs were introduced after the global financial crisis and, therefore, haven’t experienced a severe downturn yet: “One concern is that the low-volatility names could become highly volatile [during] a global market panic when investors rush for the exits.” •

“The biggest risk with these [ETFs] is that investors do not understand how they work”

I nvestment Executive’s ETF Guide 2019

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Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Although the Fund may seek to maintain stable distributions, the Fund’s distribution rates may be affected by numerous factors, including but not limited to changes in realized and projected market returns, fluctuations in market interest rates, Fund performance, and other factors. There can be no assurance that a change in market conditions or other factors will not result in a change in the Fund’s distribution rate or that the rate will be sustainable in the future. For instance, during periods of low or declining interest rates, the Fund’s distributable income and dividend levels may decline for many reasons. For example, the Fund may have to deploy uninvested assets (whether from purchases of Fund shares, proceeds from matured, traded or called debt obligations or other sources) in new, lower yielding instruments. Additionally, payments from certain instruments that may be held by the Fund (such as variable and floating rate securities) may be negatively impacted by declining interest rates, which may also lead to a decline in the Fund’s distributable income and dividend levels. All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. Investors should consult their investment professional prior to making an investment decision. Management risk is the risk that the investment techniques and risk analyses applied by the active manager will not produce the desired results, and that certain policies or developments may affect the investment techniques available to the manager in connection with managing the strategy. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2019 PIMCO. No offering is being made by this material. Interested investors should obtain a copy of the prospectus, which is available from your financial advisor. The products and services provided by PIMCO Canada Corp. may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. PIMCO Canada will retain PIMCO LLC as a subadvisor. PIMCO Canada will remain responsible for any loss that arises out of the failure of its subadvisor. PIMCO Canada Corp., 199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, Ontario, Canada M5L 1G2, 416-368-3350. CMR2019-0411-390737

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As the industry grows, big players get bigger and small firms face barriers By Mark Burgess

hen Raj Lala launched his ETF firm two years ago, there were 25 ETF issuers in Canada. Now, there are 37. “[The ETF space] is definitely becoming more crowded,” says Lala, president and CEO of Evolve Funds Group Inc. “The banks are getting more focused on [issuing ETFs]. The big asset managers are getting a bit more focused on the space as well.” (All organizations are based in Toronto unless specified otherwise.) In January, CIBC Asset Management Inc. launched its first ETFs, making it the last of the Big Five banks to enter the market. (Montreal-based National Bank Investments Inc. (NBI) followed in February.) That same month, BlackRock Asset Management Canada Ltd. and RBC Global Asset Management Inc. formed RBC iShares, a blockbuster partnership that combines Canada’s largest and fifth-largest ETF providers and distributes BlackRock ETFs through RBC’s parent bank’s network. “I don’t know whether I would do it today,” Lala says of launching an independent provider. “I don’t know that there are as many opportunities today as there were when we launched.” Canada’s ETF market continues to grow. The number of products has ballooned to 715 as of the end of June, according to data from New Yorkbased Strategic Insight Inc., compared with 513 two years earlier. There

I nvestment Executive’s ETF Guide 2019

was $181.1 billion invested in ETFs as of the end of June, up from $157.1 billion a year ago, according to NBI’s data. That 2019 figure compares with $1.53 trillion invested in mutual funds. Pat Dunwoody, executive director of the Canadian ETF Association (CETFA), says the difference between assets under management (AUM) held in ETFs and in traditional mutual funds shows there’s still plenty of room for the ETF market to expand. “If the flows continue the way they are, I can comfortably see [ETF AUM] at $500 billion in a couple of years,” she says. There are questions arising from that growth: what will that growing market look like; and will it include the smaller providers and niche products that exist today? Smaller firms face a number of challenges, including compliance costs, gaining advisor attention, competition for shelf space and cost compression that pushes investors to hold passive funds. Dunwoody says she hasn’t seen broad impact from the RBC/BlackRock deal yet. Small firms still come to market when they believe they have the right product, she says. “Whether [the RBC/BlackRock joint venture] is the first of many, I have no idea,” she adds. The RBC/BlackRock partnership has the ETF industry talking about consolidation, though. Mark Yamada, president and CEO of PÜR Investing Inc., says Canada’s market is too small for niche firms to survive. The main

PW ILLUSTR ATION / GET T Y IMAGES (2)

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barrier is shelf space: know-your-product regulations require financial advisors to know more about what they’re selling, he says, which gives advisors an incentive to draw from a narrower product shelf. From a compliance perspective, a narrow product shelf is much easier to manage than one with hundreds of ETFs. Managing liability takes precedence over product fit, Yamada says, and this favours big, established ETF manufacturers — even if small providers offer excellent products. Building a client’s ETF portfolio “is a whole lot easier if somebody knows the product manufacturer or the asset manager that is constructing these ETF portfolios; then, [advisors] don’t have to worry about the underlying product itself,” he says. “Advisors will think: ‘How could I go wrong putting an iShares product up there, as opposed to some itsy, wee, six-product ETF sponsor?’” There’s no transfer agent for ETFs that keeps track of which advisors are selling which products, which makes reaching advisors even more difficult for ETF providers, Dunwoody says. Providers know the total AUM by firm, but not at a more granular level. Although CETFA is working to build a

database, she says, ETF providers have to take a “shotgun approach” to disseminating product information. This necessity further favours banks’ extensive distribution networks. Evolve uses thematic ETFs — what Lala refers to as “conversational alpha products” — to win advisors’ attention. The company has ETFs focused on niche themes such as cybersecurity, e-gaming, the future of the automobile and gender diversity. To some extent, the products’ marketing is built into their themes. Carol Derk, partner at Borden Ladner Gervais LLP in Toronto, says niche players often use a prospectus as an opportunity to create buzz because of the distribution challenge. She’s helped firms, including Calgary-based SmartBe Wealth Inc. and Evolve, launch ETFs. “[A prospectus] is definitely much more of a marketing document for these smaller players,” Derk says. “Without that, advisors and investors are not going to be asking for those products.” Thematic ETFs also open the door to selling more conventional products, Lala says. Clients read an article about a niche product and call their broker, who asks Evolve for more information about the product. That often leads to the advisor selling a global bond or preferred-share fund rather than the niche product. “In many cases, that’s just more straightforward, in terms of positioning within client portfolios,” Lala says. Fitting a niche product such as an e-gaming ETF into a client’s portfolio is a challenge. When creating the products, Lala says, Evolve tries to offer access to new areas of the market while ensuring the holdings won’t duplicate what investors already own. For example, only three of the 37 holdings in Evolve’s cybersecurity ETF overlap the S&P 500 composite index, he says. Still, he says, “it’s not always easy for advisors to see that specific line between their interest level and how an ETF actually fits in with the portfolio.” Yamada says thematic products are the easiest way to “create mind space” among investors. But that ability still doesn’t get around the difficulty of persuading advisors who may be uncomfortable with untested products or providers to use a thematic ETF. “[Advisors] are much happier to fail conventionally than to succeed unconventionally,” Yamada says. Art Johnson, co-founder and chief investment officer with SmartBe Wealth, says big companies will dominate the index fund space, but there’s room for smaller players in active ETFs. His firm launched SmartBe Global Value Momentum Trend Index ETF in January, a multifactor product with a management fee of 0.86%. It’s SmartBe’s only ETF. Johnson’s pitch to advisors is education: if you want to understand smart beta products, that’s all his company does. “There’s a huge interest in smart beta, but there’s a disconnect,” he says. “You have to educate the advisors. Factor portfolios have to be explained.” Furthermore, advisors’ ability to demonstrate their value to their clients is “under assault,” and so is their time, Johnson says: “They just can’t be investment managers anymore; they have to be planners and they have to be estate people, and they have to have all these additional value-adds in their business to compete now.” Advisors won’t buy passive ETFs, Johnson says, “because 12

“They’re much happier to fail conventionally than to succeed unconventionally”

Investment Executive’s ETF Guide 2019

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they’re afraid that their value proposition goes away. Active ETFs are kind of the sweet spot.” Johnson says he’s working with advisors who have discretionary power who are looking to put 10%-20% of their overall book in a strategy that matches SmartBe’s. This makes for a “long incubation” period to explain the firm’s product and how it fits into portfolios. The sales cycle is six to 18 months, he says, but referrals are frequent. Factor products’ complexity means traditional ETF wholesalers, who attend multiple meetings per week, can be hard-pressed to put in the time required to explain these products, Johnson says. However, Derk says, niche players can also be more nimble than some of their larger competitors. “Because [niche players] are focused on one particular strategy, they’re much closer to what’s happening in the marketplace,” she says, while banks have more departments involved, which potentially slows product releases. ETF providers also can be optimistic that the number of advisors selling their products will increase. Dunwoody says roughly 55% of advisors licensed through the Investment Industry Regulatory Organization of Canada use ETFs — i.e., slightly more than 16,000 advisors. That’s only about 15% of the broader advisor universe if advisors who are licensed through the Mutual Fund Dealers Association of Canada (MFDA) are included, and she hopes the overall percentage will rise as MFDAlicensed advisors begin selling ETFs. “There’s still a lot of room for [the ETF market] to grow when you compare it with the mutual fund industry as a whole,” Derk says. While Dunwoody anticipates ETF AUM will grow exponentially, that may not be the case for the number of products. She says the number could plateau once banks introduce their suites. The glut of options is a concern, says Yamada, who believes the glut will lead to simple model portfolios of ETFs. Bank branch networks provide further incentive for this approach, he says: banks aren’t likely to invest in certifying MFDA-licensed branch advisors to sell ETFs, so banks will create mutual funds that comprise ETFs for those advisors to sell at competitive prices. Meanwhile, some of the 715 ETF products extant in the market today won’t remain viable. “There are so many that are just orphans out there,” Yamada says, attributing the reluctance to terminate ETFs to branding concerns. Fourteen ETFs have terminated or announced impending termination this

I nvestment Executive’s ETF Guide 2019

year as of July, according to Strategic Insight, while another five merged as part of the RBC/BlackRock deal. Issuers launched 55 over the same period. Derk says $20 million in AUM is the low end of the break-even mark for an ETF, with large manufacturers looking at $100 million. Determining when to give up on an ETF is a mix of art and science, Lala says, combining the ETF’s operating costs with an assessment of its potential to catch on. He says it’s difficult for niche products to reach $100 million in AUM. (Evolve’s cybersecurity ETF’s AUM is around $75 million.) Reaching that $100-million threshold has other benefits, though. Sometimes, Lala says, advisors may be interested in a niche strategy, only to find it averaged just $10,000 of volume in the past few days, so they change their mind. “When you get a fund to $100 million, you’ll tend to have decent volume on a daily basis,” he says, adding that reaching $100 million in AUM opens up the product to some fund allocators, institutional investors and family offices. Derk says it’s very difficult for advisors to predict which funds will endure and which won’t. For example, no one anticipated TD Asset Management Inc. (TDAM) would shut down its initial ETF products a few years after their launch in 2001, she says. (TDAM launched another lineup of ETFs in 2016.) The challenge for advisors is that they may not be able to find a comparable replacement if a niche-thematic ETF is withdrawn, Derk says. They must be able to explain to clients that there isn’t an alternative. •

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Desjardins offers a Wise way to simplify investing New portfolios are a gateway to the world of ETFs. What are many investors seeking? Rodrigue Babin describes a “one-ticket solution.” It’s a diversified product, allowing people to buy market exposure at a relatively low cost. Investors enjoy potential performance that rivals pure market returns while retaining some peace of mind. “We’re bringing access in a simple, convenient way,” says Babin, a senior product manager at Desjardins Investments Inc. To be a smart investor, you also may need to be a Wise one. Babin oversees the recently launched Wise ETF Portfolios. He says advisors can expand their product offerings with a streamlined, sophisticated turnkey investment — one that opens the door to the world of ETFs. The Wise products also have some of the lowest management fees on the market.

portfolio management by the experienced team at Desjardins Global Asset Management. “We have broad diversification, relying on large, well-recognized indices,” says Babin. What gap do the Wise ETF Portfolios fill? Babin explains that many older ETF portfolio offerings are strictly passive. Some newer offerings in the past 12 to 18 months have strongly played off factor-based approaches, and resemble more of an actively managed product. “With Wise ETF Portfolios, we’ve targeted a balance between the two,” says Babin. “We tried to keep a price point similar to passive offerings, with added elements of value.”

“We’re bringing access in a simple, convenient way.”

He points to two aspects. The first is tactical asset management. Desjardins asset managers are at the helm, rather than relying on a systematic rebalancing. As such, managers employ slight latitude in reallocating the portfolio to take advantage of market trends; they minimize the cost of ongoing maintenance and transactions.

ETFs track various indices. They can be traded like a stock Rodrigue Babin but comprise a basket Senior Product Manager, of securities. They’re Desjardins Investments Inc. growing faster than any other investment vehicle. According to the Canadian ETF Association, 37 ETF providers (up “They’re always measuring the benefit of the trades 32.1% over 12 months earlier) offer 715 funds (up they want to do against the costs,” says Babin. 16.6%) that hold $181.3 billion in assets (up 15.5%).1 The sheer number and range of choices add complexity for investors and advisors alike. The Wise ETF Portfolios cut through that, says Babin. “We think we’ve found a sweet spot,” he says. Same assets, different weights While the weights differ, the ETFs include the same underlying assets. They’re all carefully selected with the goal of improving the risk/return ratio. It’s the identical recipe, with different proportions for clients with different goals and risk tolerances. The underlying positions, about 15, are spread over 11 sub-asset classes. These resulted from strategic

Benefits of strategic beta component The second big piece of added value is the funds’ strategic beta component. It’s a way of selecting securities based on factors that, historically, have proven to have value over a market-weighted index. Desjardins works with partner Scientific Beta. The seven-year-old company began as an outgrowth of the EDHEC Risk Institute. (EDHEC is one of the top European business schools.) Scientific Beta launched with a mission to maximize the impact of the institute’s research around indexing. Today, more than 3,000 portfolio managers use Scientific Beta’s indices.

All figures as at June 30, 2019: http://www.cetfa.ca/files/1562846323_NEW-%20CETFA%20June%202019.pdf. The Desjardins Funds are not guaranteed, their value fluctuates frequently, and their past performance is not indicative of their future returns. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The Desjardins Funds are offered by registered dealers.

Rodrigue Babin Senior Product Manager, Desjardins Investments Inc.

“We like the academic rigour that goes into the construction of their indices. It’s time-tested,” says Babin. He adds that the strategic beta component addresses one of the biggest complaints of the average investor in buying an index: being fully exposed to the market and having no measure of risk mitigation. An approach to reduce volatility aims to offer a certain smoothing of returns. “The multifactor indices aim to provide some downside protection,” Babin says. A core investment He says the portfolios are another example of the leadership of Desjardins Investments Inc., one of the top investment fund manufacturers in Canada with more than $31 billion in assets under management. Desjardins Funds are backed by the strength of a century-old institution: Desjardins Group, the leading co-operative financial group in Canada and the sixth largest in the world (assets of more than $295 billion and seven million members and clients; see desjardins.com). Babin characterizes the Desjardins Wise ETF Portfolios as a core investment according to the investor profile. The portfolios assist advisors, too. Increasingly, says Babin, advisors are leaving more of the asset allocation decisions to investment firms. It frees up time to have even more meaningful conversations with clients. “You can focus a lot more on advice to clients that’s specific to their needs and objectives,” says Babin. That’s another Wise move. For more information, please visit desjardinsfunds.com/wiseetf

OSIPOVFOTO / 123RF STOCK PHOTO (2)

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he popularity of ETFs is hard to ignore. Alongside the sector’s growth, however, lies a knowledge gap; some investors don’t know what ETFs are or have concerns about the funds’ characteristics. Taken together, the increased interest in ETFs and the potential for client education represents an opportunity for financial advisors. Global growth in ETF assets under management (AUM) has exploded, reaching $4.4 trillion in September 2017 — a cumulative average growth rate of about 21% since 2005, states a research report from London-based Ernst & Young Global Ltd. (EY; all figures are in U.S. dollars). ETF portfolio managers from around the world who were surveyed for that report expect the growth to continue at a rate of 15% per annum for the next three to five years. The growth trend is reflected in Canada. The Investment Funds Institute of Canada reports that 2018 was the third year on record in which ETF net sales exceeded those of mutual funds. (ETFs now account for more than 10% of Canadian investment fund AUM, up from about 5% in 2011.) The growth story is underpinned by a shift to passive investing, states the EY report, which suggests passive funds will exceed active portfolio management within eight years. At the beginning of 2017, ETFs already accounted for half the asset base of all index-tracking funds, as noted by John Bogle in The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns (10th anniversary edition, 2017). (Bogle, who died earlier this year, founded Pennsylvania-based Vanguard Group and is considered the father of index investing.) Despite ETFs’ growing popularity, many clients don’t understand them. Mississauga, Ont.-based Credo Consulting Inc. reports that a survey of Canadian investors who don’t invest in ETFs found the main barrier is lack of

I nvestment Executive’s ETF Guide 2019

knowledge, and 52% of survey participants said they don’t know what an ETF is. Hugh Murphy, Credo’s managing director, spoke at an ETF summit presented by Advisor’s Edge and Investment Executive last autumn. He said lack of knowledge about ETFs is a lost opportunity for mass-market households in particular, considering ETFs can be a cheap investment option. (Credo’s research was conducted on behalf of the Canadian ETF Association.) Lack of understanding about ETFs may also be caused in part by criticism of passive investing. A 2018 report from New York-based S&P Dow Jones Indices LLC (SPDJI) stated that critics of passive investing sometimes “conflate issues that all market participants face with issues uniquely attributable to index funds.” With these trends in mind, here are some experts’ responses to some common ETF misconceptions:

“I would rather be in ETFs during the next crash, because I know the liquidity is there”

ETFs cause market volatility One concern is that growth in passive investing through ETFs negatively affects the market quality of the underlying securities. Specifically, there’s concern that ETF trading substitutes for and takes away from the liquidity in the underlying securities, thereby increasing market volatility. While volatility is, indeed, driven by an absence of liquidity, research published in the Journal of Portfolio Management found a positive correlation between volume changes in ETFs and their underlying securities refutes the claim that ETFs cause volatility, says Deborah Frame, president and chief investment officer with Frame Global Asset Management in Toronto, a division of Quintessence Wealth. The research also found that market volatility generally results from macroeconomic factors and geopolitics, 16

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Harnessing the power of ETF innovations Differentiating between offerings is key to investment success

The market for exchange traded funds“ETFs” ( ) in Canada continues to grow, with assets under management reaching $183.7 billion as of July 31, 2019.1 However, as these types of investments grow in popularity among both institutional and individual investors, it’ s becoming increasingly important for investment professionals and investors to realize the full utility of ETFs in achieving their financial goals. Michael Cooke, Senior Vice President and Head of Exchange Traded Funds at Mackenzie Investments, feels that advisors can potentially add significant value for their clients by expanding their understanding of ETFs and the benefits they bring beyond the well-known (and still important) characteristics of low management fees, liquidity and transparency. In particular, advisors should be digging deeper into differentiating factors such as a given ETF’ s total cost of ownership, which can vary widely depending on the ETF’ s category, its investment mandate, the impact of currency exposure and currency hedging. “It’ s important to look beyond the obvious considerations, such as management fees as the only measure of cost or trading volume as the only measure of liquidity,”says Cooke.“Advisors and investors have to ask themselves if they’ re achieving the desired exposures they’ re looking for, and how transaction-related costs such as commissions or custodial transaction costs are being managed. These costs don’ t always show up in the management fees, so sometimes you have to look deeper to really understand the total cost of ownership.” Cooke draws focus to the sometimes popular practice of Canadian investors buying U.S.-listed ETFs. It may make intuitive sense to do so, Cooke notes, owing to the wide and diverse range of U.S. ETFs, but investors need to think about choices that provide the best investment outcome to them as Canadian investors. Factors such as withholding taxes, estate taxes and currency exposure that may apply to U.S.-listed ETFs held by Canadians need to be considered. “You have to be cognizant of how to achieve the best investment experience as a Canadian. You’ re potentially exposed to different kinds of risk such as tax and currency if you own a U.S.-listed exchange traded fund, which could erode your total return.” Innovative ETFs, made for Canadians The demand for ETF solutions catering to the needs of Canadian investors but offering exposure to the wealth of innovative opportunities across the world drove Mackenzie to launch specialized ETF mandates to provide diverse strategies that are unique in the Canadian marketplace. Specifically, Mackenzie China A-Shares CSI 300 Index ETF (QCH) and Mackenzie Emerging Markets Bond Index ETF (CAD-Hedged) (QEBH), with an unhedged version of the latter to be launched at the end of September 20192, give Canadian investors entry into what Cooke sees as two critical asset classes at this juncture. In the case of Chinese stocks, particularly A-shares, (the shares of incorporated mainland Chinese companies listed on either the Shanghai or Shenzhen stock exchanges), it’ s a matter of the untapped opportunity to invest in one of the world’ s largest economies while improving the

That’s better together. global diversification of a portfolio. Despite some uncertainty with respect to China’ s market and economy, much of it driven by short-term concerns over trade disputes with the United States, the fact remains that China is now the second largest equity market in the world according to market capitalization. Cooke believes advisors can position their clients for the long term by helping them gain greater exposure to China at this stage of its economic and capital markets development. “We’ re seeing an unfolding economic miracle in China,”says Cooke. “These stages of sociopolitical and socioeconomic development entail a certain amount of volatility, some bumps along the way, as we’ re witnessing here in 2019. But they also speak to the importance of diversification: the China A-shares market has historically exhibited low correlations to developed and emerging equity markets.” With China’ s domestic equity markets only recently becoming accessible to foreign investors, the asset class is underrepresented in many institutional and retail portfolios. That means the specific expertise of the investment manager is particularly critical for investors interested in Chinese A-shares as part of the satellite component of their portfolio, and Mackenzie’ s QCH is the only Canadian ETF offering“pure-play”exposure to these securities. Cooke cites Mackenzie’ s commitment to being an independent Canadian asset manager with a global network of resources, including a key strategic partnership with China Asset Management Co., Ltd., as making the firm ideally equipped to bring such a solution to Canadian investors. In the case of emerging markets debt, it’ s a matter of yields. More specifically, the low yields investors are still seeing from their traditional fixed income assets like Canadian government bonds and GICs. “It has become very difficult in the last decade for income-oriented investors to achieve their investment objectives,”Cooke notes.“As a result, we’ ve seen higher yielding asset classes – such as investmentgrade corporate bonds, high yield bonds, senior loans and emerging markets debt – become popular with investors in recent years.” For advisors seeking to help their income-focused clients assemble a portfolio with enhanced yield and improved diversification, emerging market debt can be a valuable portfolio allocation. This is especially true given the growing size, maturity and economic stability of emerging markets paired with higher yields and favourable risk-adjusted returns, says Cooke. He points to QEBH’ s status as one of only a handful of hedged emerging market debt ETFs in Canada and its competitive management fee as key features for an advisor looking to improve a client’ s yield profile. “In the past, ETF investors have had to go south of the border to access these investment opportunities. But that’ s not necessarily in the best interests of a Canadian investor,”says Cooke.“We think it’ s important to give investors the best possible investment experience and choice from a Canadian perspective, and that’ s our objective with these solutions.”

1. 2.

Source: Canadian ETF Association, Monthly Report ($ Billions), as of July 31, 2019. Subject to final regulatory approval.

For more information on Mackenzie Investments’ETFs, visit www.mackenzieinvestments.com

PRODUCTS

which are what the market has been reacting to recently, Frame says. Robyn Graham, a chartered financial analyst with a decade of portfolio management experience with two of Canada’s leading ETF-only asset managers, says volatility “tends to be more apparent as we get into the late stages of a market cycle and people are trading on every bit of news.” Graham also notes that ETFs, as wrappers, have no inherent volatility. “It’s what’s in the basket that matters,” she says. Also, the ETF basket provides greater diversification, which is “inherently a volatility-management tool” that helps to manage risk among the underlying securities, she says.

ETFs make the whole market think and move the same way, resulting in inefficiencies and potential bubbles This misconception also focuses on passive investing. The idea is that with passive investors “buying” an entire index, market pricing becomes inefficient, with higher correlations (a measure of returns) among equities. Such inefficiency is potentially true only during short time intervals, says Craig Lazzara, managing director and global head of index investment strategy with SPDJI in New York. If this scenario were true over longer periods, the average correlation of stocks in an index would increase and remain at a high level, he says. In fact, correlations at the end of 2017 were at a 26-year low, and have been below their median levels since mid2016 despite growth in passive assets. This misconception may be based on a mistaken sense of the amount of assets attributable to indexing. For example, while the total amount of assets indexed to the S&P 500 composite index is roughly $3.5 trillion as of last year, that figure represents only about 10% of the total value of all stocks in that index, Lazzara says. Even considering all first-generation indices (not smart-beta indices), that figure is about 20%-25%, he says. Lazzara says passive investing enhances market efficiency. For example, market competition from passive alternatives, including ETFs, results in an increase in the average active portfolio manager’s ability to generate alpha, as the least capable managers lose AUM, he says. Addressing the concern that passive portfolio managers don’t contribute to market efficiency in terms of price discovery, Lazzara says price discovery is a function of trading, not of AUM, and passive AUM can easily rise further without significantly diminishing the percentage of trading volume done by active investors. For example, assuming that the annual turnover for passive and active AUM is 5% and 50%, respectively, passive AUM can rise to more than 83% of market AUM before active portfolio managers’ share of trading drops below 50%, the SPDJI report states. Graham says the market remains a mirror of myriad investor viewpoints. Although passive investing constitutes a larger proportion of trades relative to years past, investors create a healthy dynamic as they follow their respective investment policies, she says. The next market crash, she says, will probably coincide with weak economic data or geopolitics, as is typical. “I would rather be in ETFs during the next crash, because I know the liquidity is there,” she says. “We can execute our portfolio strategy tactically

Investment Executive’s ETF Guide 2019

much more easily than if we were trying to unload a bunch of individual stocks, for example — some of which might be ‘no bid’ or out of business.”

ETFs are passive regarding shareholders’ rights A criticism noted in the SPDJI report is that index fund portfolio managers may not be good stewards of investors’ assets if the portfolio managers are less concerned about company governance as they focus on keeping investors’ costs low. But, Lazzara says, the big ETF providers have increased their stewardship efforts in recent years, engaging with the management of companies in which they invest. “Indexers have [greater] incentive to interact with corporate management” because they can’t sell individual stocks. Graham says ETF providers typically have stated policies for proxy voting — an important consideration for investors, given their increased interest in sustainable investing. Furthermore, she says, clients can choose ETFs that invest “responsibly.”

ETF investing is simple and requires no advice Regardless of the tools used to invest, Graham says, clients need advice to ascertain their ideal asset mix based on their risk level and objectives. And, as portfolio tools, ETFs can be simple or complex. For example, a single balanced, active ETF may suffice for a do-it-yourself investor (see story on page 18), while a sophisticated portfolio manager may actively trade several ETFs daily. Bogle recommended the Main Street investor avoid the wealth-eroding effects of costly trading. Thus, his investment advice remained unchanged as ETFs gained popularity during his lifetime: find an inexpensive, classic index fund and hold it for the long term. For clients who like the idea of sector ETFs, “invest in the appropriate ones and don’t trade them,” he wrote. Frame describes ETF investing as an opportunity to access the part of the market driven by macroeconomics and geopolitics. Her firm uses broad-based ETFs to create model portfolios to minimize risk in various economic environments. That’s a skill set distinct from stock-picking, she says. Those skills are important, given a landmark 1986 study by Gary Brinson et al, entitled Determinants of Portfolio Performance, that found portfolio returns are determined largely by asset allocation, and only 10% by specific investments. Investors most willing to pay for advice and those interested in ETFs may be the same clients. Credo’s research found that ETF investors are more likely to get advice compared with other investors (28% vs 19%, respectively). That may be the result of having sufficient investing knowledge to be aware of what they don’t know: the research also found that ETF investors are more financially literate than other investors — the former group scored 79% on a test vs 29% for non-ETF investors. •

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STRATEGIES

Two advisors weigh in on balanced ETFs, and build their own ETF portfolios By Greg Dalgetty

alanced ETFs give investors a one-ticket solution when deciding where to put their money. This class of ETFs, which is offered by all four of Canada’s largest ETF providers, delivers diversified asset allocations, low management fees and simplified account statements in a single product. But are financial advisors recommending balanced ETFs to their clients? “There are some advisors who use them for their small accounts to keep things simple, but I think that’s almost making [the choice] a bit too simple on the advisory side,” says John De Goey, portfolio manager with Winnipeg-based Wellington-Altus Private Wealth Inc. in Toronto. “But in terms of do-it-yourselfers, I think that maybe 25% to 30% of all DIY inves tors would be well served, and perhaps even better served, to use a single-ticket solution rather than try to pick stocks or funds, or time markets.” Ryan Lewenza, senior vice president and portfolio manager, private client group, with Toronto-based Turner Investments, which operates

Investment Executive’s ETF Guide 2019

under the Raymond James Ltd. umbrella, says balanced ETFs are a “great idea for DIY investors,” but suggests there’s little logic in a client paying you a fee to recommend a product they can purchase on their own. “It doesn’t make sense to get a financial advisor, pay me a fee and then buy that fund I sent you. Why are you paying a fee?” Lewenza says. There also are potential drawbacks to the funds themselves, De Goey says, such as limited options for asset allocation. For example, he says, if you are looking for an allocation of 70% equities/30% fixed-income, but can find only products that have a 60/40 or 80/20 mix, “you might need to build [the portfolio] yourself.” Another concern is that if a client buys a balanced ETF through an advisor and has specific questions about it — such as how it gets rebalanced — you may be hard pressed to provide answers. “What are you [as an advisor] going to say if [a client] asks why you have only a 4% weighting in emerging markets?” Lewenza asks.

CHRIS TURNER / GET T Y IMAGES WITH ADDITIONAL FILES FROM 123RF STOCK PHOTO

STRATEGIES

Investment Executive asked both De Goey and Lewenza to compare a balanced ETF with a model ETF portfolio of their own development. Both portfolio managers opted to go with a 60/40 equities/fixed-income mix, but, other than that, their choices were markedly different. (All ETFs are listed on the Toronto Stock Exchange, except where indicated on the chart on page 20.)

John De Goey: Keep it simple De Goey’s theoretical client is a 40-year-old male professional with $100,000 to invest: “Young, decent earner, smart — but not financially smart — and straight down the fairway in terms of traditional objectives,” De Goey says. For the balanced ETF, De Goey went with

Vanguard Balanced ETF Portfolio (TSX: VBAL), which offers a 60/40 equities/fixed-income allocation with a management expense ratio (MER) of 25 basis points (bps). The Vanguard ETF invests in a portfolio of index ETFs, including Vanguard U.S. Total Market Index ETF and Vanguard Canadian Aggregate Bond Index ETF. “A single-ticket solution such as this one gets you the traditional best risk-adjusted return and keeps the focus on the most important determinant of that risk-adjusted return, which is the 60/40 asset allocation,” De Goey says. “It does the most important thing cheaply, efficiently and effectively.” When De Goey constructed his model ETF portfolio, he went with a similar 20

“It doesn’t make sense to get a financial advisor, pay me a fee and then buy that fund I sent you. Why are you paying a fee?”

Investment Executive’s ETF Guide 2019

1 9

STRATEGIES De Goey’s choices Balanced ETF ETF Vanguard Balanced ETF Portfolio

Symbol VBAL

Asset allocation 60% equities/40% fixed-income

ETF portfolio ETF

Symbol

Weight

Asset class

iShares Core S&P/TSX Capped Composite Index ETF

XIC

20%

Canadian equities

FTSE Global All Cap ex Canada Index ETF

VXC

40%

Int’l equities

iShares Core Canadian Universe Bond Index ETF

XBB

40%

Bonds

19 approach, keeping things Source: Wellington-Altus Private Wealth Inc. IE simple and cost-effective for his hypothetical client. Lewenza’s choices De Goey allocated 20% of his model portfolio to iShares Core Balanced ETF S&P/TSX Capped Composite ETF Symbol Asset allocation Index ETF (TSX: XIC), 40% to iShares Core Balanced ETF XBAL 60% equities/40% fixed-income FTSE Global All Cap ex Canada ETF portfolio Index ETF (TSX: VXC) and 40% to iShares Core Canadian Universe ETF Symbol Weight Asset class Bond Index ETF (TSX: XBB). The Cash 1% Cash entire portfolio has an average BMO Ultra Short-Term Bond (Accumulating Units) ETF ZST.L 4% Bonds MER of 16 bps, so the ongoing cost is lower than VBAL’s. Mackenzie Core Plus Global Fixed Income ETF MGB 3% Bonds De Goey chose XIC, which has Vanguard Canadian Short-Term Bond Index ETF VSB 8% Bonds an MER of 6 bps, for its broad WisdomTree Yield Enhanced Canada Aggregate Bond Index ETF CAGG 9% Bonds range of Canadian equities, which include large-caps such as ToronDynamic iShares Active Preferred Shares ETF DXP 15% Preferred shares to-Dominion Bank (6.0%) as well BMO Low Volatility Canadian Equity ETF ZLB 10% Canadian equities as mid- and small-cap companies. PowerShares Canadian Dividend Index ETF PDC-T 6% Canadian equities For the international component, iShares S&P/TSX Capped REIT Index ETF XRE 5% Canadian equities VXC — which De Goey describes as “one of my favourite products iShares Core S&P 500 Index ETF (CAD-Hedged) XSP 7% U.S. equities ever” — offers exposure to comSPDR S&P 500 ETF Trust* SPY 4% U.S. equities panies of all sizes in developed and Vanguard Value ETF* VTV 4% U.S. equities emerging markets for an MER of 27 bps. “I think [this ETF] is a really Vanguard Health Care ETF* VHT 3% U.S. equities great way to get broad exposure to BMO MSCI EAFE Hedged to CAD Index ETF ZDM 9% Int’l equities [markets] around the world, to get iShares Trust MSCI EAFE ETF* EFA 2% Int’l equities that cheaply and get it tax-effectively,” he says. Vanguard FTSE Emerging Markets ETF* VWO 6% Int’l equities On the fixed-income side, XBB Vanguard FTSE Europe ETF* VGK 4% Int’l equities invests in corporate and govern*ETFs are traded in U.S. dollars and listed on the New York Stock Exchange ment bonds of varying durations Source: Turner Investments IE and has an MER of 10 bps. “There are other products that might allow you to use different strategies, but they’re going to cost you more money. And if the objective is to keep Half of the bonds in Lewenza’s model portfolio have short durations [the choice] simple and get broad exposure to the bond market, this [ETF] is because the flat yield curve means investors aren’t compensated for going extremely broad and extremely simple and quite cost-effective,” De Goey says. long. The largest bond allocation (9% of the portfolio) is in WisdomTree Yield Enhanced Canada Aggregate Bond Index ETF (TSX: CAGG), which Ryan Lewenza: A granular approach holds investment-grade provincial, municipal and corporate bonds and has Lewenza, whose practice focuses on clients who want a 60/40 mix, regardan MER of 20 bps. less of demographic, stayed true to that investment philosophy in his A large share of the equities portion of Lewenza’s model portfolio — product selection for his model portfolio. 21% of the total — is focused on Canadian equities, with 10% going to For the single-ticket option, Lewenza chose the iShares Core Balanced ETF BMO Low Volatility Canadian Equity ETF (TSX: ZLB). Being overweighted (TSX: XBAL), another 60/40 equities/fixed-income product with a managein Canada, he says, takes advantage of the dividend tax credit: “If it’s Canment fee of 0.18%. He favours XBAL for its long track record and size (it had adian-earned, you get a lot more money in your pocket than [with] a U.S. assets under management of $157 million as of August 2019), and low cost. or a U.K. dividend.” (See story on page 22.) On the fixed-income side, 15% of Lewenza’s model portfolio is in Overweighting in Canada also reduces currency risk associated with Dynamic iShares Active Preferred Shares ETF (TSX: DXP) to maximize tax being overweighted internationally, Lewenza adds. Further, he foresees efficiency while interest rates remain low. “In an incredibly low interest rate developments such as our federal government’s approval of the Trans Mounenvironment, preferreds are giving us a yield of about 4.5% to 5% in divitain Pipeline as being a potential catalyst for Canada’s economy. dends,” he says. “So, if you [compare dividends to] an interest equivalent In U.S. equities, Lewenza focused primarily on large-cap stocks as a means after adjusting for taxes, you’re looking at closer to 6% to 7%, compared of reducing risk in his model portfolio. The portfolio is overweighted interwith bond yields giving you 2% to 3% or GICs giving you 2%.” nationally — at 21% — due to the attractive price of European equities. •

I nvestment Executive’s ETF Guide 2019

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Tax consequences to consider before deciding how to invest in foreign equity ETFs

TFs are a cost-effective, efficient way for your Canadian clients to gain exposure to U.S. and other foreign equities markets and achieve diversification within their portfolios. However, when investing outside Canada using ETFs, clients need to take into consideration the effect of foreign withholding taxes (FWT) on their investment earnings. Most countries levy FWT, withheld at source, when corporations pay dividends to foreign investors. The rate of FWT applied differs depending on the country in which the foreign corporation is domiciled and the country in which the investor is resident. For example, the U.S. government imposes FWT of 15% when U.S. corporations pay dividends to Canadian investors, a percentage that is based on the tax treaty between the U.S. and Canada. That means when a $100 dividend is paid to a Canadian client by a U.S. company, $15 is withheld at source. There are two key factors in determining if and how FWT applies to an ETF, and whether those taxes can be recovered by the investor. The first factor is the structure of the ETF. Canadian investors looking for exposure to foreign investments via ETFs typically will own: • a Canada-listed ETF that invests in U.S. or international equities directly; • a U.S.-listed ETF that invests in either U.S. or international equities; or • a Canada-listed ETF that holds a U.S.-listed ETF in the portfolio as its primary investment. There are two levels of FWT to which an ETF may be subject. The first type of FWT is applied by the country in which the underlying foreign investments are domiciled — the Level 1 FWT. In addition, in the case of a Canada-listed ETF that holds a U.S.-listed ETF that, in turn, invests in international (non-U.S.) equities, or a U.S.-listed ETF that invests in international equities, two levels of FWT may apply. The first is the FWT that’s withheld on dividends paid by the foreign companies to the U.S.-listed ETF that holds shares of those foreign companies (a.k.a. the Level 1 tax). The other level of FWT is withheld by the U.S.-listed ETF on dividends paid to a Canadian investor or a Canada-listed ETF — the Level 2 FWT. The second factor in determining if and how FWT applies is the type of account in which the ETF is held.

Non-registered accounts If a client’s non-registered account holds a Canada-listed ETF that invests in U.S. or international equities directly, or a Canada-listed ETF holds a U.S.-listed ETF that invests solely in U.S. equities, Level 1 taxes apply. The

I nvestment Executive’s ETF Guide 2019

By Rudy Mezzetta

client may claim a foreign tax credit (FTC) on his or her annual tax return to recover Level 1 taxes. The same scenario applies if the client’s account holds a U.S.-listed ETF that invests in U.S. equities. However, if a client’s non-registered account holds a Canada-listed ETF holding a U.S.-listed ETF that, in turn, invests in international equities, both Level 1 and Level 2 taxes will apply. The client can claim the FTC to offset the Level 2 taxes, but not the Level 1 taxes. The same scenario applies if the client’s account holds a U.S.-listed ETF that invests in international equities. Because of these factors, a Canada-listed ETF that holds international equities directly “is generally considered the way to go,” as opposed to holding a U.S.-listed ETF that invests in international equities directly, says Wilmot George, vice president of tax, retirement and estate planning with Toronto-based CI Investments Inc. The Canada-listed ETF faces one level of taxes, which is recoverable, while a similar U.S.-listed ETF faces both levels, only one of which can be recouped.

TFSAs, RESPs and RDSPs ETFs that invest outside Canada are subject to a different set of stipulations when the ETFs are held in TFSAs, RESPs and RDSPs. If one of these registered accounts holds a Canada-listed ETF that holds U.S. or international equities directly, or a Canada-based ETF holds a U.S.-listed ETF that, in turn, invests solely in the U.S., Level 1 taxes apply and the client cannot claim an FTC. The same scenario applies if the client’s account holds a U.S.-listed ETF investing in only U.S. equities. If a client holds a Canada-listed ETF that holds a U.S.-listed ETF that, in turn, invests in international equities in a TFSA, RESP or RDSP, both Level 1 and Level 2 taxes apply — and the client can’t claim an FTC. The same scenario applies if the client’s account holds a U.S.-listed ETF investing in international equities. For these registered accounts, holding a Canada-listed ETF that invests in international equities directly is always preferable to a holding similar U.S.listed ETF, says Justin Bender, portfolio manager with PWL Capital Inc. in Toronto: “If you hold a U.S.-listed ETF, you’ll have one layer [of FWT] lost from those international companies paying [dividends] to the U.S. fund, and then you’ll have a second layer [of FWT] lost from the U.S.-listed ETF to Canada.”

RRSPs, RRIFs and other retirement accounts When held in an RRSP or RRIF, Canada-listed ETFs that hold U.S. or international equities directly or indirectly (through U.S.-listed ETFs) are subject

DANIEL GRIZEL J / GET T Y IMAGES

STRATEGIES

STRATEGIES Tax considerations for converting mutual fund portfolios to ETFs Many clients have considered converting their mutualfund based portfolios into ETF portfolios, whether because they’re drawn by cost considerations or by a desire to embrace index investing. However, if a client has held a portfolio of mutual funds for many years, he or she may have built up a significant amount of unrealized capital gains. If all the fund units were to be sold at once in favour of ETFs, the client may be left with a hefty tax bill. In this context, you must discuss strategies with that client to manage the transition to ETFs from mutual funds. You should first look to see if the client has any other equities that may not be performing well, says Chris Gandhu, vice president of high net-worth planning with TD Wealth Financial Planning. Selling these equities

allows the client “to offset or match capital gains with capital losses, and perhaps result in a tax-neutral position,” he says. Any unused net capital losses can be carried back to reduce taxable capital gains in any of the three preceding tax years or forward to any future tax year. In addition, the client should consider the timing of the sale of the mutual fund units. For example, if all other considerations are equal, selling an investment with a capital gain earlier in the calendar year is preferable to later, Gandhu says: “If we sell something and trigger a gain late in the year, we know we have to file a tax return by April, and pay our taxes by then. But if we wait [to sell] until after Jan. 1, then the tax return is not due until April of the following year. [That way,] there’s a bit of a [tax] deferral, you buy [yourself] a bunch of months.”

to FWT (see chart below). This provision also applies to other retirement accounts, such as individual pension plans and locked-in retirement accounts. Because these are tax-sheltered accounts, clients cannot claim the FTC. However, a tax-advantaged exemption exists when a client’s RRSP or one of these other retirement accounts holds a U.S.-listed ETF that invests in U.S. equities. Under the Canada/U.S. tax treaty, the U.S. recognizes RRSPs and certain other retirement accounts (but not TFSAs, RESPs or RDSPs) as being tax-exempt, so no FWT applies. If a U.S.-listed ETF that invests in international equities is held in a retirement account, Level 1 taxes apply (and can’t be recovered), but Level 2 taxes don’t apply. The exemption means holding a U.S.-listed ETF (which invests in U.S. equities) in an RRSP or other retirement account is more tax-efficient for a client than holding a Canada-listed ETF that invests in U.S. equities, Bender says. In addition, U.S.-listed ETFs may offer lower management expense ratios than their Canada-listed equivalent, Bender says: “There would be a slight product [cost] advantage, generally.” U.S.-listed ETFs that invest in U.S. equities may be best suited to clients with larger RRSPs and more than $100,000 in foreign equities, Bender suggests: “That’s usually where you get the most bang for your buck.” However, balanced against this advantage, you and your client must keep in mind a host of other considerations — primarily, the cost of converting Canadian dollars to U.S. dollars to purchase U.S.-listed ETFs. Unless conversion costs can be mitigated, the advantage of the exemption will be reduced or lost. In addition, there may be other tax reporting and compliance obligations associated with owning U.S.-listed ETFs, which are considered foreign property. For example, calculating the adjusted cost base for U.S.-listed ETFs is a trickier process because currency exchange rates on the dates transactions were made have to be factored in. As well, a client whose non-registered account holds foreign investments, including U.S.listed ETFs, with a cost of $100,000 or more must file a Form T1135: Foreign Income Verification Statement annually with the Canada Revenue Agency.

ETF Structure

Clients also should consider their current tax bracket, and whether it’s likely to change in the following year. Depending on whether taxable income is expected to be higher or lower next year may influence the decision about the best time to sell. Of course, taxes should be only one consideration when contemplating a sale, says Wilmot George, vice president of tax, retirement and estate planning with Toronto-based CI Investments Inc. You and your client should ask if any investment in the client’s portfolio has become inappropriate or too risky for the client. “Are you prepared to pay taxes on the [capital] gain? The answer might very well be yes,” George says. Gandhu agrees that taxes are but one consideration: “Look at the overall picture.” — Rudy Mezzetta

Failure to do so may result in heavy penalties. A Canadian client who, at death, owns more than US$60,000 of “U.S. situs” property, which would include U.S.-listed ETFs, may expose his or her estate to a U.S. federal estate tax-filing obligation, says Chris Gandhu, vice president of high net-worth planning with TD Wealth Financial Planning, a unit of Toronto-Dominion Bank. While only the wealthiest Canadians will have a U.S. estate tax liability, compliance alone can be another burden for an executor. “There are fairly stiff penalties that kick in for non-compliance,” Gandhu says. Finally, while clients should be aware of the FWT, they shouldn’t let it overwhelm other tax and investment considerations, Bender says: “I’ve been asked by investors whether they should not contribute to their TFSA and, instead, use their non-registered cash to purchase an international equity ETF [because the] FWT is generally recoverable in a taxable account, but lost in a TFSA. [These clients] don’t consider the tax bill they’ll have to pay on the dividend income each year and the taxes they’ll pay on their capital gains [when the investment is sold]. In this case, [it’s] better to contribute to the TFSA, purchase the international equity ETF and not worry about the FWT drag.” •

Account Type and Applicable Withholding Taxes RRSP, RRIF etc.

TFSA, RESP, RDSP

Non-Registered

U.S.-listed ETF holding U.S. equities directly

Exempt

Level 1

Level 1 creditable

Canada-listed ETF holding a U.S.-listed ETF holding U.S. equities

Level 1

Level 1 creditable

Canada-listed ETF holding U.S. equities directly

Level 1

Level 1 creditable

Level 1; Level 2 exempt

Level 1 + Level 2

Level 1; Level 2 creditable

Level 1 + Level 2

Level 1; Level 2 creditable

Level 1

Level 1 creditable

U.S. Equities

International Equities U.S.-listed ETF holding international equities directly Canada-listed ETF holding U.S.-listed ETF of international equities Canada-listed ETF holding international equities directly

Source: CI First Asset ETFs

Investment Executive’s ETF Guide 2019

2 3

GEORGIJEVIC / ISTOCKPHPOHOTO

OPINION

How to communicate the essentials without getting lost in the weeds By Mary Hagerman

hen managing ETF-based portfolios, I focus on three important attributes: returns, risk management and cost. When speaking to clients, I like to tell them a story about my experience with the Great Recession. The global financial crisis of 2008-09 was a turning point for the way I managed money. Like everyone else in the financial services industry, I felt helpless watching the value of my clients’ portfolios sink over an 18-month period. No one could have predicted the extent of the damage done by the recession, including the active money managers who tried desperately to avoid the full brunt of the market’s decline. I did not lose my faith in capital markets during that time. Indeed, the greatest lesson I learned in the four years the markets took to return to their pre-recession highs was that trying to trade my way out of a market downturn was a futile exercise; staying invested in order to recapture full upside was the way to make money over time. My experience during the financial crisis allows me to say with authority and conviction that I do not believe the majority of portfolio managers who use an active strategy can outperform their benchmark index. I use the S&P Indices Versus Active (SPIVA) Scorecard’s numbers to back up my claim. Since the crisis, the amount of financial literature available to support index strategies has grown considerably, but SPIVA has some of the most compelling marketing materials to convince clients that traditional index-based strategies have a better chance of outperforming over time. “But what happens when markets go down?” we are often asked. “Can’t active management help limit losses?” Not necessarily, as is shown by calculations by the Vanguard Group using data from Morningstar Inc., and other data from Wilshire Associates Inc., MSCI Inc. and the Center for Research in Security Prices. But statistics alone don’t sell portfolios. Financial advisors must use the right terminology when explaining ETFs to clients. Using the word “passive” to explain an ETF strategy has opened the door to questions — not only from clients, but from colleagues: “If we say we have a passive investment strategy, it sounds as if we aren’t doing anything.” Telling clients that you are charging them a fee to generate benchmark returns will certainly not get you far, because the inevitable response is “I can do that by myself. Why do I need you?” or “Benchmark returns are not enough. I want outperformance.” That’s where the focus on the investment process plays a critical role in winning a client’s trust. Most portfolio managers agree that asset allocation has

I nvestment Executive’s ETF Guide 2019

Clients often ask: “But what happens when markets go down?”

the greatest impact on portfolio returns. Even with the best suite of index investments, being overweighted or underweighted in an asset class, geographical region or sector can have an impact on portfolio returns. Once I have made my investment case for using ETFs in our portfolios, I spend a lot of time explaining to clients how I interpret market research to build and diversify our portfolios so they can provide consistent returns over time. ETFs help with risk control because I know exactly how my portfolios are invested from one day to the next. I choose from a variety of index strategies — market capitalization, rules-based, low volatility — to determine the best asset allocation for all of our investment profiles. There is no more talk of “passive” in the way we manage money. The ETF sector has grown so much since I began managing portfolios that passive has become active because of the way we choose the products we use. ETFs have helped bring about some of the biggest changes in the investment industry in recent years, such as transparency and the downward pressure on the cost of investing. I like to remind our clients that we were early adopters of portfolios that allow us to keep costs low. There is no better way to convince a client that you are acting in his or her best interests than to say you are invested in the same products he or she is. I built all of our portfolios with my (and my family’s) money — and I tell clients that. I never put anything in our portfolios that I wouldn’t buy for myself. I believed the late Jack Bogle, founder of Vanguard, when he said that in 60 years of investing, he had never met anyone who even knows someone who can predict where the markets are going. So, although I will never try to pretend I’m the smartest person in the room, I just might be the most disciplined at taking as much of the emotion out of the investing process as possible. ETFs are the core of my investment thesis and I make sure clients understand why: with stories, numbers and language that is clear and transparent — just like my portfolios. • Mary Hagerman is founding partner, portfolio manager and investment advisor with the Hagerman-Archambault Group in Montreal, which operates under the Desjardins Securities Inc. umbrella.

OPENING KEYNOTE HOW LONG CAN ETF GROWTH LAST? Dave Cassie will share the insights identified through the PwC’s global ETF survey, Roadmap to Growth, on both a global and local Canadian level. He will discuss the expected growth in the sector, including what factors are required to be successful when entering and growing within the Canadian ETF market. Considerations will include asset classes, ETF types and distribution.

PORTFOLIO CONSTRUCTION: USING ETFs TO SOLIDIFY YOUR CORE Establishing a scalable portfolio construction process delivers value to investors and advisors alike, and ETFs are an ideal tool for building solid and scalable portfolio foundations. Trevor Cummings will explore how ETFs can be used in the core by discussing portfolio construction concepts and ideas, industry trends, and actionable examples of how to get started. Presented by our Platinum Sponsor, RBC iShares.

INTERACTIVE C-SUITE DISCUSSIONS Replacing the traditional Executive Panel discussion, this new interactive, small-group format will focus on sharing knowledge through forward-thinking content and heightened audience engagement. This interactive session encourages delegates to discuss and debate their views on the ETF market, as well as ETF strategy, with the C-suite from a select group of fund companies. Presented by our Interactive C-Suite Discussions Sponsors. Speakers include: Julian Klymochko (CEO, Accelerate), Duane Green (CEO, Franklin Templeton Canada) & Dean Orrico (CIO, Middlefield Capital Corporation)

AGENDA HIGHLIGHTS

LUNCHTIME PRESENTATION GET OUT OF YOUR OWN WAY: HOW TO GIVE ADVICE THAT CLIENTS WILL FOLLOW Neuropsychologist Dr. Moira Somers has spent the last decade investigating why clients don’t follow financial advice and finds that part of the problem is advisors themselves. In this illuminating talk, Dr. Somers will explain the ways advisors unintentionally sabotage their own advicegiving and share concrete, evidence-based strategies for boosting advice adherence among clients. Advisors will hear practical methods that they can implement the next day and beyond.

ETFs: THE IDEAL RETIREMENT INCOME VEHICLE?

TUESDAY, OCTOBER 1 TORONTO REGION BOARD OF TRADE 77 ADELAIDE STREET WEST

Thanks to their lower fees and tax efficiency, ETFs can help clients at all stages who are looking for income. ETF expert Andrew Clee will explain how advisors can use ETFs to construct diversified portfolios that optimize for age and demographic challenges, particularly for retirees who are decumulating. Respected tax expert Michelle Munro will then connect Andrew’s insights to findings from Fidelity’s 2019 retirement survey, Retirement 20/20, which showed that Canadians are retiring earlier than expected, but with more financial obligations than their predecessors. Presented by our Gold Sponsor, Fidelity Investments Canada.

ETFs: A REGULATORY PRIORITY The Ontario Securities Commission (OSC) has made it a priority to examine the unit creation process for the ETF market. Hear more details from the OSC’s director of Investment Funds and Structured Products, Raymond Chan, on what the OSC is hoping to achieve when it comes to product regulation, distribution and disclosure for both active and passive ETFs.

CLOSING KEYNOTE GEOPOLITICAL FAULT LINES – THE END OF MULTILATERALISM AND THE NEW WORLD ORDER Political disruption is happening around the world in ways we haven’t seen since the Second World War. Brexit and the election of Donald Trump are two of the most visible examples, but we are also seeing the rise of populism in Italy, Mexico, Brazil and other countries. Additionally, there is an increasing rejection of global multilateralism, which has many far-reaching political, economic and social implications. Charles Myers, a New York-based global policy expert, will explore the most important of those implications in his talk.

Learn more at investmentexecutive.com/ETFsummit2019 Platinum Sponsor

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National Bank’s Daniel Straus reflects on the proliferation of ETFs and what to expect in the years ahead By Patricia Chisholm

PAUL L AWRENCE

PEOPLE

aniel Straus is vice president, ETFs and financial products research, with Montreal-based National Bank of Canada in Toronto. He holds a master’s degree in finance and a PhD in engineering, and he is a frequent speaker and media commentator on the topic of ETFs. He spoke with Investment Executive about the outlook for ETFs and some of the trends in the sector.

What do you see as the key factors influencing the performance of ETFs in the coming year?

It’s true that there is very much a growing area of ETFs with active strategies, [a.k.a.] smart beta or factor strategies. But the reality is that more than 80% of assets, especially globally, have been going to ultra-low-cost ETFs that track mainstream, broadly diversified indices. If the global economy remains on a good footing and all these macroeconomic headlines that are related to trade

ETFs are not a silver bullet against the No. 1 problem that plagues investors, and that is their own behaviour 26

Investment Executive’s ETF Guide 2019

and geopolitics subside and turn out to be much ado about nothing, the prospects are still good for [the ETF sector’s] growth and for positive investor outcomes over the very long term.

ETFs are sometimes viewed as a silver bullet in terms of generating returns, but they can also lose money. Do you think investors understand this?

ETFs are not a silver bullet against the No. 1 problem that plagues investors, and that is their own behaviour. For better or worse, human beings have a tendency to “performance chase”— to compare their results with the outlier, best-in-class [investment fund], which may very well have been lucky. Investors also have a tendency to avoid risks that, in their life circumstances, would

be prudent to take. These are the classic problems that underpin all of investing, whether you are using a directly held stock-andbond portfolio or a managed mutual fund or ETF. ETFs are held up as champions of the investor class because of their incredibly low cost and liquidity, and they do solve a lot of problems. But when it comes to underlying global problems or investor behaviours, in some cases, [certain] ETFs may exacerbate them. That’s because, in some cases, ETFs are often sold by the same fund companies that wish to profit from investor behaviour. There are a lot of ETFs out there that are part of investment fads, but then again, [the companies selling such ETFs] are in the business of making things that people want to buy. So, the problem is already there; it’s certainly not caused by ETFs.

PEOPLE

Daniel Straus, vice president with National Bank of Canada, believes ETFs are at the forefront of educating clients about what’s in their best interests.

their websites, white papers they have published, fact sheets for their funds, videos and webinars. I really do think that if you’re talking about the mainstream, large ETF companies have really shifted the tide in the way investors are educated.

Does that extend to the fees that investors pay for ETFs?

Paradoxically, the ultra-low cost of ETFs only serves to highlight the fees charged by the advisor

Are financial advisors and manufacturers of ETFs doing a good enough job of educating investors about the downside of ETFs as well as the advantages?

ETFs are at the forefront of truly educating investors about practices that are in their best interests — controlling costs and knowing what you’re buying. Lift the hood of an ETF and understand what stocks and bonds are inside it. If it’s an index-tracking ETF, do some due diligence about how that

index works. I wouldn’t say every single investor needs to know the niceties of every single index rule, but that’s why we’re ETF research analysts and we do that as a service for our clients. ETFs predate the “fintech” buzzword, but that’s what [ETFs] are. They are a form of algorithmically traded baskets [of securities]. And because they’ve always had trading technology in the background, the companies that offer them, because they are so technologically inclined, have really done a lot in the form of, [for example,] disclosure on

a small percentage difference, but the magic of compounding really means that if you can control fees, then that’s an enormous benefit to the investor. And I think that’s why there have been so many assets gravitating toward ETFs.

Are there situations in which mutual funds are better?

I don’t want to say that every ETF is ultra-low cost. The reasons we love ETFs is because they are low in cost, very transparent, highly diversified and tax-efficient. There are ETFs out there that are not all of those things. In fact, there are ETFs that are none of those things. But, by and large, the big ETFs — the ones that are popular; where the most assets are going — are very transparent and are ultra-low in cost. And when I say “low in cost,” I mean disruptively low in cost. Mutual funds in Canada have been charging something north of 2%, all in, if you count advisor compensation and so on. But there are ETFs out there that charge as low as three basis points, which is 0.03%. The difference between that and 2%, over a long term — when you are compounding for a long time — is astronomical. In fact, more than half of your money can disappear over a 30- or 40-year compounding period and be eroded by fees if they are as high as 2%. When I deal with students, I show how the difference between 5% and 7% [as an example of a reasonable market return] compounded annually is the difference between one dollar turning into $11 and $1 turning into $30. That seems like

The fact that ETFs can be traded so frequently is a double-edged sword. It promotes the kind of investor behaviour that we, in our capacity as analysts, try to discourage, which is excessive trading. It’s nice to be able to trade intra-day, but trading multiple times a day? All the academic research shows that that tends to act as a drag on [the investor’s portfolio] performance. You don’t need to sell or even buy on every single headline. Mutual funds, with their lag in selling time [due to net asset values set only at the end of the day] act as a speed bump to some of the worst excesses of investor behaviour.

Do we have too many types of ETFs being marketed? Are there too many flavours?

It’s a valid concern. There are about 800 ETFs in Canada and 2,000 in the U.S. But, at the same time, nobody bats an eyelash at the number of mutual funds. There are about 8,000 mutual funds in Canada. And that’s not a problem. So, I think it’s not a fundamental concern or risk to see this many [ETF] products. If anything, it might cause some investor confusion, but I think that risk is minimal; it’s certainly not a systemic issue. 28

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Can you comment on the relationship between this newer, more technical type of investing and traditional, advice-based models of investing?

The [value] of advice is really huge, and I hope it doesn’t go away. I think it’s a major part of the services that our industry offers and I think that there are many, many add-ons to the service of advice in general that are extremely important. ETFs are highly amenable to that service because of their very low fees and transparency. In Canada, there is a migration to a fee-based service. We have seen a range of these [arrangements, for which, for example], a 1.25% fee would be normal. And if you then place a client into a well-diversified, very balanced portfolio of ETFs charging 30 to 50 basis points, the overall fee charged to the client is still much lower than it would be in the mutual fund world.

This model makes the fee much more obvious. Paradoxically, the ultra-low cost of ETFs only serves to highlight the fee charged by the advisor. If the advisor is charging 1.25% and is placing the client into an ETF portfolio that charges, on a weighted average basis, 0.25%, then the client is overall being charged 1.5%. Perhaps that is reasonable, but then the client might say, “I am paying my advisor five times as much as the fund companies.”

What do people get wrong about ETFs?

The No. 1 issue is trying to educate investors that the liquidity of an ETF is not related to the [trading] volume of that ETF on the screen. People who are accustomed to trading stocks recognize that if a stock trades only a handful of shares per day, or zero shares, then that’s an illiquid security and buying and selling it might affect the price. ETFs don’t behave that way. An ETF’s liquid-

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ETFs are at the forefront of truly educating investors about practices that are in their best interests — controlling costs and investors knowing what they’re buying ity [is driven] internally by its underlying basket [of securities]. That is a pretty crucial point to understand.

Any other issues you’d like to address?

The blurring of the lines between mutual funds and ETFs. There are more and more active [investment funds] coming to market. There are more and more mutual funds launching F-versions of their mutual funds. There are ETFs that are less transparent than what we’ve grown accustomed to in terms

of their disclosure because there are active [portfolio] managers who are concealing what they think is their “secret sauce” or [growth]-generating strategies. In the coming years and decades, I think that we will see a complete migration of asset-management technology into ETF-like structures. Already, we are seeing headlines [that state] mutual fund companies have really not been selling their products and it’s only ETFs that are growing in the world. In Canada, certainly, the distinction between mutual funds and ETFs may be harder to tease apart. •

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PEOPLE

A vice president at one of the largest ETF providers in the U.S. shares her thoughts on where the industry is headed

hanna Weber, vice president, head of strategy and product development with San Francisco-based Charles Schwab Investment Management Inc. (CSIM) in Denver, can trace her enthusiasm for financial services to a single high-school business course. “I got hooked on business,” Weber says. “I just got really interested in how businesses worked.” A natural talent for mathematics took Weber to the University of Arizona, where she completed a dual major in finance and management, graduating at the top of her class. A series of positions in the asset-analysis and fund-development sectors followed. Weber, now head of product development and strategy with CSIM — one of the largest ETF providers in the U.S. — has spent almost two decades in the financial services business. “I’ve never looked back,” she says. “I’m so passionate about product development — because you actually get to solve people’s problems.” Weber was recruited by CSIM in 2015, after spending several years at the Denver office of Janus Capital Group Inc. She launched a wide array of products during her stint there, including several globally focused investment vehicles. Her initial role at CSIM involved streamlining the firm’s product lineup, which had been pieced together over a number of years as the result of several acquisitions. Her initial assignment, she says, was to enhance the firm’s competitiveness in an investing environment that was rapidly changing. Some of the innovations she oversaw included adjusting the pricing of mutual funds to match that of ETFs. Weber’s primary focus now is to build on CSIM’s long-standing commitment to improving investors’ access to investment products. Part of that initiative includes a class of commission-free ETFs available through online trades

DANIEL PET T Y

By Patricia Chisholm

— an option for investors that was first offered by CSIM and has since been copied elsewhere. “We believe investors shouldn’t have to compromise what they are getting. We don’t want them to make trade-offs between price and quality,” Weber says, referring to the thinking behind the commission-free model. These ETFs allow financial advisors to trade some ETFs online for clients without paying trading commissions that would otherwise eat into clients’ service fees. The model has been popular, Weber notes: the commission-free group of products now consists of more than 500 ETFs, including products from third-party providers, which cover more than 80 investing categories. Such innovations are fuelling a global appetite for ETFs. Global inflows for ETFs have reached US$3.3 trillion over the past decade, and that figure is expected to swell to US$12 trillion by 2023. That phenomenal demand has led to intense competition in the sector for new assets, resulting in fee and commission wars that have pushed ETF costs to unprecedented lows. The trend toward lower costs, in turn, is helping to shift the investing conversation from one that has been heavily focused on fees — sometimes to the exclusion of other considerations — to a broader discussion about the investing options that are best for a client’s particular needs and life stage, Weber notes. “We definitely feel that cost is going to continue to be part of the conversation,” Weber says. “But when we get to the point where we are talking one or two or three basis points, is cost really a differentiator? We encourage investors to think holistically: ‘Cost is definitely important, but how does the product work within your portfolio? What service are you getting from the provider? What types of products are you getting from the provider?’” These types of questions, she says, should be considered as carefully as cost is. 30

“We don’t want [investors] to make trade-offs between price and quality”

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PEOPLE Shanna Weber, vice president with Charles Schwab Investment Management Inc., is committed to improving access to investment products

Recent research found that clients get much better at looking at the big picture regarding their portfolios when financial goals are addressed in this broader manner, Weber says. “Investors look for ETFs to meet both their short-term and long-term investment goals,” she says, citing a 2019 client survey conducted by CSIM. “That is the great beauty of an ETF. You can have it as a core holding in your portfolio and you also can use it more tactically during different market environments.” The survey also found that all investors, particularly millennials, are enthusiastic about ETFs, Weber says: “We found that two-thirds of all investors surveyed actually planned to increase their ETF investments in the next year, and 80% of millennials plan to increase their investments in the next year.” Perhaps even more indicative of the future of ETFs, 44% of millennials participating in the survey said they would consider placing their entire portfolio, including cash, in ETFs. Simple familiarity may be driving that interest among younger investors. While older investors originally stocked their portfolios with mutual funds and other traditional investment products, and the latter group of investors had to acclimatize themselves to ETFs as a newer product with distinct technical features, millennials grew up with ETFs, Weber points out. Ten years ago, when millennials as a group began investing in earnest, ETFs in the U.S. already held US$500 billion in assets under management. “It wasn’t like [ETFs] were the new weird thing [for younger investors],” she says. “[This asset class] was just an option.” Today’s younger investors also are different from older generations in that the former tend to be more conservative when investing, Weber notes, with research over the past decade finding that millennials hold about 70% of their assets in low-risk vehicles and about 30% in equities. That is a ratio that, Weber says, may require adjustment. “I think it’s the job of advisors and asset managers to really educate people on what risk is and that [clients] need some risk in order to participate [in investment growth],” she says. “So, there has been a lot of effort to try to help all investors understand how a portfolio works.” Indeed, helping clients better understand the range of investment choices by educating advisors has been a priority for CSIM, Weber says. The firm has developed ETF KnowHow, a program with tools and resources for advisors. Weber also is deeply committed to education of another kind: developing the roles of women already in the ETF sector and informing younger women of how they can build careers in a field they may not have considered. Weber is a co-founder of the Denver chapter of Women in ETFs, a global, nonprofit organization that promotes participation of women in the ETF sector through education, mentoring and networking. When the organization was established five years ago, Weber says, the vision was to “grow, support and inspire women across the ETF ecosystem. Pretty simple goals.” Women in ETFs has taken off around the world, including in Canada, and the experience of the Denver chapter illustrates the group’s popularity: the chapter’s first event attracted more than 80 attendees from 42 companies in the local ETF sector. Weber recalls being surprised by the turnout. “I can’t

even name 42 companies [in this sector],” she jokes, “and they were all here in Denver.” The Denver group has since grown to 300 members and, Weber says, she knows of women who have landed jobs as a result of the networking opportunities that the group provides. As is often the case in such initiatives, knowing whether an individual woman’s efforts to move through the ranks are hampered by external forces — such as the biases of others — or by her lack of confidence and vision for herself can be difficult. Weber doubts that outright bias in the workplace is holding women back, but she does think bringing men who hold leadership positions into the conversation is important. They may need help in understanding what is important to women and how those men can support women in their career growth, Weber says. Initiatives such as mentorship programs, flexible work schedules, equal pay, promotion opportunities — and even becoming more aware of biases that men may unknowingly transmit in meetings — help to lower barriers for women. In addition, Weber says, recruiting women to the financial services field early is essential to addressing the still overwhelming majority of men in senior positions. What is needed, she says, is to build a new “pipeline” that over decades will funnel talented and committed women into positions that provide the potential for entry to the executive suite. That includes connecting with female high-school and college students to dispel their preconceived ideas that women who enter the financial services field face a narrow range of options. Weber says that the financial services industry in general could do a better job of stripping away myths and its sometimes tarnished image as a closed, elite club with murky ethics. “The [global] financial crisis didn’t help. Bernie Madoff didn’t help,” Weber says. “Historically, people view the financial industry as very conservative, very money-driven; you think of plush corner offices and Wall Street, with mahogany cabinets and expensive suits. But the reality is that’s not what the industry is anymore. And I think of companies that really try to manage costs and expenses, and pass that on to investors and build products that help investors reach their goals, and offer educational opportunities.” She points out that CSIM, for example, visits high schools to teach students the basics of running their own finances, from opening a bank account to using credit cards responsibly. “Hopefully, that helps us recruit people from diverse backgrounds,” Weber says, “as well as helping our clients trust us more. That is what we really focus on.” •

“Investors are really looking for ETFs to meet both their short-term and longterm investment goals”

I nvestment Executive’s ETF Guide 2019

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