Examining some uncomfortable truths about ETFs: Ottawa 2016

By Yves Rebetez, ETF Insight

Special to the Financial Independence Hub

An uncomfortable truth … and the reason to examine Regulation; Technology Disruption; and Convergence – the topic of ETFinsight’s upcoming Mar 3+4 Ottawa event.

In the movie The Big Short, Steve Carrell’s character, Mark Baum, is a hedge fund specialist coming at the world with a cynical take: “Let me understand how I am being screwed,” can’t believe what he hears and sees… The fact is … conducting some out-of-the-box and on-the-ground due diligence that will guide whether he bets against US Housing … that things are way worse than he ever fathomed, and unbelievably so, everyone seems to be in on it.

Perhaps on a more serious note – while not suggesting the Great Recession we are still struggling to fully recover from wasn’t , despite several scenes in the movie easily drawing out cynical laughter … I recently attended a presentation at the Ontario Securities Commission, speaking to the topic of Advisor Compensation & Investor Outcomes, as well as Mutual Fund Fees, Flows, and performance.

In my view – in relation to these OSC commissioned studies, two critical takeaways stood out:

• Compensation shapes behaviour (Prof. Edwin L. Weinstein, PhD) + yes, the financial industry needs to be paid and be healthy.
• The presence of Trailer Fees skews fund flows – resulting in a suboptimal allocation of capital (Prof. Douglas Cumming). True Alpha generators should take significant exception to this, amongst others…

So – what uncomfortable truth? From my perspective, and the reason for hosting Ottawa 2016 next week, the uncomfortable truth consists of several factors we are all responsible for, and which, if not addressed, will continue to have a “taxing” effect on us all:

• Smart(er) wins – In an industry, finance, priding itself on being smart and beating the system, the reality is that by definition, most don’t, particularly once costs, which can be high, are taken into consideration. This, by the way, is confirmed, and reaffirmed yearly in an industry piece called the SPIVA report. (Standard + Poors Index versus Active). The study, in essence, examines how Active Funds fare, relative to the simple and straight forward proposition of buying the index to which you’d like to have exposure
• True Active – Just because a mutual fund markets itself as “Active” (pursuing a clearly delineated investment mandate and discipline to select exposures and holdings) doesn’t mean it will be successful at sufficiently differentiating itself from the Index it seeks to beat – by being “Active”. This is very important, as absent the differentiation, and cum the high fees typically prevalent in Canada (which according to Morningstar continues to have amongst the world’s highest mutual fund fees, if not the highest) hoping to do better than said index is a guaranteed impossibility. Simply put – “it ain’t ever gonna happen”.
• Inertia – Whether the Financial Industry here suggests it is helping investors deal with lower expected future returns by making increasing use of low cost solutions such as Exchange Traded Funds or not, the numbers suggest otherwise. The only number to look at in that context isn’t the growth rate of the ETF Industry in Canada, but its relative importance versus the Mutual Fund Industry. Until the needle moves significantly toward low cost ETF solutions, the reality is that a combination of the “Compensation shapes behaviour”, respectively not borne out expectations that “Smarter wins” will result in Canadians allowing themselves to be taxed unnecessarily, without any realistic hope of significant improvement in terms of outcome, also known, down the line, as after tax (and fees…) returns.

So, everyone can expect for someone else to take the lead on that file, OR, you can start being part of the solution, and help yourself and your clients identify smarter and more cost effective ways of getting to better outcomes. Disruptive technologies in that respect, include Exchange Traded Funds – an innovation that first originated in Canada back in 1990, as well as the more recent arrival on the scene of ETF Strategists; and ROBO Advisors.

For if not – just realize – we, as Canadians have all entered the perfect storm – Commodities are out of favour – ask our Oil Sands sector – we are shackled with high fees, a high “closet indexing” constituency, and a pervasively high home bias. Combine all three, and in this world of and in disruption we’re living through, the odds are not stacked in our favour. On the other side, if you think that our savings, housing, etc. are helpful, think again: our level of indebtedness has never been higher; real estate values have been artificially inflated, such that even at exceedingly low mortgage rates, we soon won’t be able to afford our homes anymore (Property taxes anyone?); and our savings rate? Well, you know about that one, we keep being reprimanded by various finance ministers on the topic.

Join us at ETFinsight – Ottawa 2016 on Mar 3+4, and hear from a variety of speakers addressing Disruption (Deloitte’s Michel Brazeau); the ROBO, and ETF Strategists solutions (Wealthsimple; Wealthbar; Forstrong; SIA Wealth; Resolve Asset Management); the state of True Active Management in Canada (Prof. Martijn Cremers, University of Notre Dame; Craig Lazzara, S&P|Dow Jones); how the Canadian Pension Plan Investment Board “Focuses Capital on the Long Term” (Poul Winslow, Head of Thematic, and Outside Portfolio Managers); and … whether Canada is in fact on the verge of an 08/09 real estate moment (Jared Dillian). For that matter, come and listen to a talk on the battle for the ETF Revolution’s Soul, by Factset’s Dave Nadig. And, just as importantly, hear from Prof. Douglas Cumming) on the effect of trailer fees (totalling CAD 6 Billion back in 2009) on flows and performance.

See you there!

Yves Retetez, CFA, is editor of ETF Insight. Before launching the site he was vice president of ETFs/Structured Products with RBC Dominion Securities between 2004 and 2011.