Active ETFs Gain in Canada in Challenge to Mutual Funds

Updated on
Active ETFs Surging in Canada
Canada has the highest percentage of actively managed exchange-traded funds in the G7

Actively managed exchange-traded funds are surging in Canada, posing a challenge to the mutual-fund industry that Morningstar says has among the highest management fees in the world.

Assets in actively traded ETFs jumped to about $7.33 billion as of May 31, up almost 50 percent from a year ago, according to data compiled by Bloomberg. The funds, which hire portfolio managers to pick stocks, have also outperformed their index-tracking ETF peers this year and now make up about 11 percent of Canada’s $69-billion ETF industry, the most among developed markets, the data show.

“Actively managed ETFs have been the largest driver of asset growth for our business over the last three years,” said Steve Hawkins, co-chief executive officer of Horizons ETF Management Canada Inc., best known for its leveraged ETFs. More than half of Horizon’s C$4.65 billion ($3.7 billion) assets under management are now actively traded funds, Hawkins said in an interview at Bloomberg’s Toronto office.

The rise in active ETFs come as Canadian securities regulators implement new rules to improve cost transparency in a country where mutual-fund fees are the world’s highest, according to a Morningstar report.

Under Client Relationship Model Phase 2 amendments, firms will be required to provide more detailed account statements, and beginning in 2016 will have to submit annual reports to clients showing how much advisers were paid for products and services.

D Minus

“For investors who want to remain in active funds, Horizons will start to look a lot more attractive,” said John Gabriel, an analyst at Morningstar in Chicago. “With their ETFs they’re looking to take a chunk of the mutual-fund pie. People may see their products and start to migrate.”

Canadian mutual funds received a grade of D- on fees, the worst out of 25 countries in a June Morningstar report. The U.S., Australia and the Netherlands tied for the best scores in the gauge, which measures ratios across different categories. Canadian management expense ratios average 0.61 percent for ETFs and 1.86 percent for active mutual funds, according to Morningstar. Active ETFs average 0.66 percent, Bloomberg data show.

Ian Bragg, senior manager of research and statistics at Investment Funds Institute of Canada, disagrees with Morningstar’s findings. He argues that while Canadian fees generally include embedded distribution and adviser costs, those elements are stripped out of U.S. fees, making them appear lower.

Economies of Scale

Canada also suffers from a lack of price competition, economies of scale and a smaller environment of independent investors, Morningstar said.

Horizons Active Canadian Dividend ETF has fees of 0.7 percent and posted a total return of 63 percent in the past five years, compared with 50 percent for its benchmark, the Standard & Poor’s/TSX Canadian Dividend Aristocrats Index.

Actively managed ETFs in Canada climbed 4.1 percent on average in the 12 months through June 29, compared with a 2.5 percent advance in passive ETFs, according to data adjusted for asset size compiled by Bloomberg. Active equity ETFs have surged 6.9 percent, ahead of a 2.8 percent advance for passive equity ETFs, the data show.

U.S. Lags

While active ETFs are taking off in Canada, they account for only about 1 percent of the $2.1 trillion U.S. ETF market. The return of U.S. active ETFs has dropped 1 percent in the past year, compared with a 2.6 percent increase for passive.

The funds have struggled to gain traction in the U.S. because Americans tend to put more emphasis on cost when choosing investment vehicles to save for retirement, said Eric Balchunas, a Bloomberg Intelligence analyst in Skillman, New Jersey.

As well, in contrast to the U.S., Canadian regulators don’t require firms to disclose their holdings daily, Hawkins said. That reduces concerns over competitors front-running trades.

On the bond front, active ETFs don’t always have to sell assets to match an index’s move, reducing liquidity qualms, he added. Horizon’s C$555-million Active Corporate Bond ETF, managed by Fiera Capital Corp., is among the firm’s best sellers.

ETF Testbed

Hawkins, 47, took over in March as co-CEO of Horizons, a unit of Seoul-based Mirae Asset Global Investments Co. He primarily focuses on day-to-day operations of the firm’s Canadian, U.S. and Colombian operations while Co-CEO Taeyong Lee oversees the firm’s global businesses.

Horizons faces growing competition in actively managed ETFs including from First Asset Investment Management Inc., which has rolled out several products since September, including the First Asset Active Canadian Dividend ETF.

Canada has been an investment testbed since it debuted the world’s first ETF in 1990 with the Toronto 35 Index Participation Units. Horizons launched the world’s first leveraged commodity ETF in 2008. Its more recent products have included an ETF based on trades of corporate insiders.

ETF assets under management climbed to a record C$85.1 billion as of May 31, according to data from the Canadian ETF Association. Horizons has a 5.5 percent market share while leader BlackRock Inc.’s iShares has 54 percent, followed by Bank of Montreal and Vanguard Group Inc.

Most Conservative

The industry remains small compared with the mutual fund market, whose assets have advanced 8 percent this year to a record C$1.23 trillion as of May 31, according to data from the Investment Funds Institute of Canada.

“I don’t think we’re feeling any particular threat from ETFs,” IFIC’s Bragg said. “We see mutual funds and ETFs as different products serving different needs and they can work together.”

Still, some of Canada’s biggest mutual fund providers are investigating getting into ETFs, including Toronto-Dominion Bank and Mackenzie Investments, a unit of IGM Financial Inc, that manages about C$75 billion.

Mackenzie Investments is “still in the exploration phase and have made no decisions at this time” on pursuing ETFs, said Jeff Carney, CEO of Mackenzie, in an e-mail.

Toronto-Dominion CEO Bharat Masrani told reporters in March the lender may resume offering ETFs in Canada after exiting the business in 2006. Meghan Thomas, spokeswoman at the lender, declined to comment.

Canadians are among the most conservative investors in the world and even with the incoming rule changes are unlikely to abandon investment advisers en masse for ETFs, said Brian Gooding, head of distribution at Mackenzie.

‘Wild West’

“There will be a subset of people who decide they’re not getting value,” Gooding said. “It will be minimal.” Mackenzie offers fees as low as 0.85 percent on equity mutual funds for do-it-yourself investors, Gooding said.

Horizon’s push into active ETFs will help the company double its assets past C$10 billion in the next five years, Hawkins said.

“The perception has been they’re the Wild West, leveraged ETF provider but they’ve quietly amassed assets in the actively managed space,” Morningstar’s Gabriel said. “They’ve done a nice job moving away from that reputation.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE