ETFs aren’t just for passive investing anymore

Even though many investors cling to their mutual funds, the traditional mutual fund companies are feeling the pressure of ETFs and are coming up with their own products to ensure are not left behind. In April 2022, ETFGI, an independent research and consultancy firm specializing in ETFs, reported there was been a 22% compound annual growth rate in smart-beta ETFs globally in the previous five years. 

It was only a matter of time before those structures pushed their way north. A steady stream of new active and smart-beta ETFs is coming to Canada this year giving investors more options, not just in the number of choices, but in investment style. Manulife launched a set of ETFs managed by Dimension Financial Advisors a few years ago. Dimensional is a U.S.-based mutual fund company that is a pioneer in using factor-based models to build portfolios that are based on academic research. They are not alone. Franklin Templeton, a global investment management organization that until recently specialized in active mutual funds has been expanding into ETFs in recent years. Factor ETFs have also been introduced by the likes of iShares, BMO, Vanguard and Horizons.  

More ETFs mean more choice

“Clients are asking about ETFs, and that’s growing globally obviously, and we want to bring that choice to our clients,” says Patrick O’Connor, global head of ETFs for Franklin Templeton Investments. 

Templeton plans to bring even more ETFs to Canada, but it doesn’t have any plans to enter the crowded passive ETF market. “Our DNA is active,” says O’Connor. “That’s not a space we want to play in; it doesn’t speak to who we are.” 

Interestingly, two of the three primary fundamental ETF focuses of low volatility and multi-factor saw small outflows of assets year-to-date in 2022 as of September. Environmental, social and governance (ESG) ETF growth saw the largest percentage increase in flows relative to assets under management.

Too much choice?

Investors may welcome the new ETF flavours, but as the saying goes, be careful what you wish for. “It’s exciting for investors, and terrifying for investors,” says Mark Yamada, president and CEO of Pur Investing, which builds ETF portfolios for both individuals and institutional clients.

The new flavours of ETFs are more difficult to digest and the added choice could overwhelm investors. Yamada cites the research of Sheena Iyengar, S. T. Lee professor of business at Columbia University. Iyengar found that while consumers will pay more attention to markets that offer more choice, too many options tends to have a paralyzing effect. The end result is, if there are too many options consumers tend to put off their decision.

Canada now has 42 ETF sponsors and 1,010 funds as of Aug. 31, 2022, managing $324 billion in assets. Individual investors are going to find it more difficult to build their portfolio on their own, says Yamada. In the end he says he expects investors may need an advisor to help them make the decision. 

The good news is the new entrants into the ETF market will signal lower fees for Canadian investors, says Yamada. That’s critical. While you’ll never know what your return is going to be, you’ll always know your costs, explains Yamada. 

Competition is keeping costs down

Not only will the added competition in the ETF space help keep costs down, but it’s also offering investors alternatives to more expensive mutual funds. The Templeton funds, for instance, typically cost between 0.3 and 0.6%. Franklin Templeton’s mutual funds, by comparison, typically have MERs over 2%.

Only time will tell whether smart-beta ETFs will perform better than traditional ETF offerings. Until then, it’s up to you to decide if any of these products are right for you. 

More about ETFs:

• How to choose ETFs for your investment portfolio
• How to evaluate ETFs based on financial reports
• What seasoned investors look for in an ETF prospectus
• The importance of asset allocation