Special to the Financial Independence Hub
Last Friday, ETFs (Exchange-traded Funds) surpassed the magic $100 billion mark in assets under management in Canada and hopefully, continued growth in the markets and sales will keep us moving forward. But this milestone signals that many investors are gaining greater appreciation for these powerful, low cost and transparent investment vehicles.
And the industry is growing rapidly with new providers and products joining the ranks, regulatory changes on the horizon and technology changing the investment management field, like it has many others.
But the doubling of assets and tripling of ETF providers since 2010 is an indication that ETFs are being integrated into more investors’ portfolios. We see this every day with a growing number of ETF options and lower costs across the industry.
While there are a multitude of factors for the rising popularity of ETFs, I wanted to take a deeper look into four in particular.
- The rise of indexing.
- Increased competition.
- Regulatory efforts to increase the transparency and awareness of investment fees.
- More fee-based financial advisors.
The rise of indexing
Canada was an early innovator in ETFs, as the first ETF in the world was listed here in Canada 26 years ago. But the marketplace for these flexible, lower-cost products actually developed relatively slowly here for much of the last quarter century. One reason is that index-fund investing has accounted for a small portion of AUM in Canada compared with actively managed investments – just 12% as of December 2014.1 However, passive investing has been on the rise since the end of the global financial crisis, and ETFs have typically been passive investments.
Now, as Canadians are allocating more to index-based investments, they’re increasingly choosing ETFs. In 2014, ETFs accounted for 82% of the cash flows into passive investments.2 While mutual funds remain the dominant investment product for many Canadians, ETFs have been gaining AUM at a higher rate on a year-over-year basis compared with mutual funds—16% versus 8% as of December 31, 2015.3
Competition within the ETF industry is growing every day. At the end of 2007, there were only two ETF providers in Canada. Today, there are 13,4 including Vanguard, which entered the market in December 2011. Between 2008 and March, 2016, the number of Canadian ETFs rose to 424 from 77 while AUM increased to $95.0 billion from $19.4 billion.5
Greater transparency and awareness of investment fees
Shifts in the regulatory environment designed to benefit investors have also provided momentum for low-cost ETFs. Client Relationship Model (CRM) reforms in Canada require advisors to provide greater fee transparency to clients. When the requirements of the second phase of the CRM reforms are fully implemented by July 15, 2016, investors will receive a more complete picture of the impact of costs on their investments, including an annual summary of all advisor fees and compensation, such as trailer fees and transaction costs.
Fee-based versus commission-based practices
In response to these regulatory changes in Canada, many financial advisors have been adjusting to help clients understand what they’re paying for and why.
A large number of advisors have migrated to a fee-based model from a commission-based structure. Fee-based advisors tend to favour ETFs because of their transparency and low costs.
If Canada were to follow the lead of the United Kingdom and Australia, which have banned commissions, or if competitive forces drive greater change as has happened in the United States, advisors would have even more incentive to use lower-cost investments, including ETFs, as building blocks for client portfolios.
These changes are reshaping the investment industry in Canada and ETFs stand at the forefront of this shift. After reaching the 25th anniversary of the first ETF being offered in Canada, there are many lessons and opportunities for both ETF providers and investors in the years ahead. It will be an exciting time that rewards organizations that put the needs of investors first , treat them fairly and positions them for success.
Atul Tiwari is managing director and head of Vanguard Canada. He is also the chairman and a director of the Canadian ETF Association.
1 Christopher B. Philips, Francis M. Kinniry Jr., Todd Schlanger and David J. Walker, April 2015. The case for index-fund investing for Canadian investors. Valley Forge, PA: The Vanguard Group, Inc.
2 Source: Morningstar, Inc. as of December 31, 2014.
3 Vanguard calculation using Investor Economics data for ETFs from CETFA and Investor Economics data from mutual funds from the Investment Funds Institute of Canada’s monthly Industry Overview report. Data as of December 31, 2015.
4 Source: CETFA monthly report as of February 29, 2016.
5 Source: Vanguard analysis of Investor Economics data from CETFA’s monthly reports on the CETFA website, including the most recent as of March 31, 2016.