Financial information in figures on stock market ticker.

Update on the Canadian mutual fund and ETF industry

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Mutual Fund & ETF Specialist Luke Kahnert joins host Chris Cooksey in this episode. Luke and Chris look at the mutual fund and ETF industry, what are the trends, what are flows indicating and other interesting aspects that should be considered when looking at investing into these products, including:

  • What is new in the Canadian mutual fund and ETF industry?
  • What were some of the top takeaways from this year’s report from IFIC?
  • Do you see these growth trends for ETFs continue as we move forward and do you think, at some point?
  • Can you provide some reasons for why we are seeing this continued ETFs growth?
  • Growth in the ETF industry has been helped by ETFs have evolved from passive investing to other options, e.g. rules-based ETFs.
  • Can you touch on some of other innovations we’ve seen in ETFs over the years?
  • What other research can you provide when looking back at 2023?
  • What do you think might be a factor that will affect next year’s IFIC report?

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Chris Cooksey: Hello and welcome to the Advantaged Investor, a Raymond James limited podcast, a podcast that provides perspective for Canadian investors who want to remain knowledgeable, informed, and focused on long term success. We are recording this on March 6, 2024. I'm Chris Cooksey from the Raymond James Corporate Communications and Marketing Department, and today Mutual Fund and ETF Specialist Luke Kahnert returns to the podcast. Today, Luke and I will be discussing the goings on in the Canadian mutual fund and ETF space. Welcome back to the Advantaged Investor, Luke., thanks for taking the time. We are headed towards episode 100. You are episode 91, I believe, so we're getting close to that big number. So, thank you for taking the time to join today and look forward to hearing what you have to say. I hope you're doing well.

Luke Kahnert: That's great. Thanks for the opportunity, Chris. I thought you were about to say I'm episode 100. I was getting pretty excited.

Chris Cooksey: Hey, play your cards right and you can be! Anyway, glad you're doing well., and obviously this is a very large part of the Canadian investment landscape. So a lot to talk about and let's jump right in and let's start off with a nice broad based question. What is new in the Canadian mutual fund and ETF industry?

Luke Kahnert: Sure, I came prepared with some data from IFIC's annual funds report for 2023. For our listeners, just to clarify, IFIC is the Investment Funds Institute of Canada, and they regularly release these monthly reports on mutual fund and ETF data within Canada, but they also release an annual report that comes out with some great data just summing up the calendar year, which illustrates some ongoing trends that we've seen in both mutual funds and ETFs over the last decade or so.

Chris Cooksey: I guess there's some important takeaways from these reports, important stuff in the executive summary so to speak. So maybe you can just comment on that.

Luke Kahnert: Sure. The biggest takeaway from the report from last year or 2023 annual report is the ETF industry continues to grow consistently year over year. When looking at ETF growth for 2023, ETF assets grew by almost 22%, whereas mutual funds grew by about 7%. It's also important to note that when we evaluate and look at it from a total assets, mutual funds still dominate with $1. 9 trillion in net assets as of the end of 2023. And you know, at the end of the year ETFs were occupying about $382 billion. There's still a lot of room for ETFs to catch up in terms of total assets, but certainly some strong growth coming from the ETF industry.

Chris Cooksey: Now when we think of those growth trends, do you think it's a case of ETFs catching up to mutual funds or some mutual fund investors going to ETFs and thereby balancing it out eventually, or maybe a little column A, a little column B.

Luke Kahnert: Yeah, that's a great, that's an interesting question. First off, I think both mutual funds and ETFs are great investment vehicles to consider, and there may be an advantage in using one versus the other for a specific investment scenario that a Raymond James advisor can certainly help explain. When you look at the data over the past decade, ETFs have certainly outpaced mutual funds in terms of growth, so the trajectory over long term points to ETFs. continuing to maybe close that gap in assets over time, depending on how fast that is, who knows. But there's a lot of reasons for why there's, there's been such strong growth within ETFs, that's for sure.

Chris Cooksey: What are some of the reasons why maybe new investors are going towards ETFs? Maybe what's fueling this growth, if you will.

Luke Kahnert: Yeah, so good question. The number the number of players in the ETF industry that are now focused on strategies outside of traditional passive index ETFs have helped in terms of growth. These strategies will include what are called rules-based or smart beta ETFs. In addition, there's an increasing number of active ETF strategies that are available in the marketplace. Typically, ETFs have been known for their passive characteristics and now that we're finding so many new flavours within smart beta, rules based and active ETFs, there's just so many more solutions that investors can find that go beyond just that pure passive index ETF exposure.

The second thing I'll mention is we're seeing more and more asset managers launch ETF versions of existing funds. So by funds, I mean existing mutual funds. From an investor's perspective, this provides just another option to access an active strategy that was previously only available in a mutual fund structure. If an investor's preference is to use an ETF, they may now be able to access that mutual fund strategy they've grown to love over the years in ETF form. I'm seeing many mutual fund providers now look at growing out their ETF shelf using existing mutual funds strategies. And again, there are times where mutual fund structure may be advantageous to an ETF structure and vice versa. In any case, the increasing number of ETF purchase options is a tailwind for overall ETF industry growth.

Thirdly, institutional clients are now big users of ETFs. That definitely helps ETF flows especially over the last decade. And the last thing I'll mention, Chris, is that the ETF industry just continues to innovate. It seems like every year we're constantly seeing new products come to the market to help address a specific investor need, and this push for innovation has certainly contributed to supporting the ongoing growth that we've seen within the ETF marketplace over the last decade.

Chris Cooksey: And just as a point of clarity when you said passive ETFs, those are the first ones that came aboard your SPDRs, your QQQs, your TIPS, they just mimicked the index, so whatever the index returned, the investor returned basically.

Luke Kahnert: Exactly. Yeah, that's correct. The world's first ETF was launched in Canada in 1990. The ticker is XIU and it's the iShares S&P TSX 60 index ETF. So pure passive exposure.

Chris Cooksey: Okay. And then as you said, now it's starting to evolve. whatever you're playing, oil or more specific sectors or whatnot. And that's part of that's what's fueling the growth is the options within the ETF space has grown tremendously.

Luke Kahnert: Exactly. Yes.

Chris Cooksey: All right. You mentioned briefly the rules-based ETFs, maybe just come up with what that means, because it's a lot more complicated than mimicking an index, I would imagine.

Luke Kahnert: Absolutely. Yeah. So I just mentioned that that one ticker being the first ETF ever launched in the world, XIU, purely passive you know, tracking an index. So that's where kind of ETFs, first became popular for lack of better words, but and, and, and since then, ETFs have kind of been labeled as passive strategies because that's where they, that's where it began as index tracking vehicles. And then, on the flip side, mutual funds have always been looked at as their active counterparts. You know, an active strategy will include a portfolio manager that is evaluating investment opportunities, buying, selling, trimming positions within the portfolio. And the ultimate goal is to outperform their respective benchmark, which is usually an index such as the TSX in Canada or the S&P 500 in the US. So, a combination of indexes, and there could be a blend. It all depends. And this is something that's predetermined within the investment approach of the mutual fund, or ETF now, for that matter. But it's kind of a long-winded answer, but this way of thinking has obviously changed with ETFs, just being passive mutual funds being active as now there are rules-based ETFs. They'll follow a predetermined set of rules and their investment methodology. Some examples include low volatility, ETFs, momentum, ETFs, dividend ETFs - ETFs that are tracking companies that pay out a dividend. This really kind of opens up the number of options that we have now just growing from that pure passive index ETF.

I guess where it all kind of began and building off of that rules-based ETF methodology, what you'll find is it's kind of a midway between active and passive, and typically what you find is the MER will also land somewhere in between that passive and active MER. I mean, over the years the media oftentimes compares ETFs to mutual funds, but now that the lines have blurred so much between the two vehicles you know, we've got all these different kinds of ETFs available. The real comparison that I think is worth following is active versus passive. Which is a whole other discussion.

Chris Cooksey: Right, absolutely. And is it a consolidation of the industry that's bringing everything together? Or is it just a little bit of both? It's just the way it is, what opportunities are out there for managers and that sort of thing.

Luke Kahnert: Yeah, exactly. I mean there's been a lot of there's been a lot of growth and innovation. We're seeing a lot of products that include derivatives within their investment methodology I think now that fixed income has become a popular asset class today with where rates are, there's more of a focus now on fixed income ETFs and mutual funds for that matter. So it really depends on the environment, I would say, but but ETFs have kind of helped out in a lot of different ways. I guess the, you know, just kind of sharing a few others, like one that comes to mind is. Physical gold ETFs. So great innovation where the ETF provides that convenience structure to you know provide exposure to the price movements of gold without the investor having, having to actually hold the physical commodity, which is obviously very convenient.

Chris Cooksey: Also would strip out the company aspect of it. If, the company is making the right decisions, you're just investing in the commodity itself rather than the industry per se.

Luke Kahnert: Exactly. Yes. Or there's also the ETF that will you know provide exposure to gold producers as well. So you can do that as well. There's so many ways where you can find specific exposures in an ETF vehicle and a mutual fund vehicle are both very convenient for adding that to a specific sleeve in a portfolio, but we're seeing a growth in asset allocation ETFs over the last five years or so, and this is like an ETF of ETF structure, if, if that makes sense.

Chris Cooksey: Okay, like the old fund of fund almost then, right? Like it's your whole portfolio based on a few ETFs type of situation.

Luke Kahnert: Exactly. Yeah. So you can get, with one ETF, you gain exposure to say five ETFs under underlying ETFs that are within the portfolio. So a fantastic way to just simply diversify with one ticker.

Chris Cooksey: Now, I imagine you look at more than one piece of research and it's not just the IFIC report. So what other research caught your eye last year, coming into this year?

Luke Kahnert: Great question. Last year was dominated, in terms of flows, with money market ETFs in particular and funds too. A lot of the investor interest was falling into HISA ETFs, T-bill ETFs or just traditional money market ETFs, which is interesting. Just looking and I get reports from our ETF partners, when you look at year to date, and of course there's only been two months, but when you look at year to date flows, it's almost completely flipped where now there's been so much interest in investor demand in a U S equity and international equity ETFs. We're actually seeing some outflows from the money market ETFs that were gaining so much traction. And that's just a byproduct, I think of what we're seeing this year and maybe what the market is pricing in terms of rate cuts.

Chris Cooksey: I was going to suggest that, obviously the industry environment has a huge impact into that because if rates go up and you can get whatever 5%, I don't even know if that's realistic, so you can correct me there, but like if you get, we're getting 5 percent in a ETF or a GIC or whatever, then that doesn't mean I necessarily have to put as much into the equity markets. And as investors and professionals start thinking rates are going down; all right, how do we position the portfolio to take advantage of any growth that might come because of the rate/inflation environment.

Luke Kahnert: I think you nailed it. I think it's a great way to measure investor sentiment by looking at flows and when you see launches of specific ETFs as well. So year to date, just this year alone, I'm seeing a lot of continued interest in launching fixed income ETFs. And in particular, there are many target date bond ETFs that have come to market.

Where I know we're kind of touching on a variety of ETFs here, but these ETFs act like a standalone bond, they mature like a bond, they offer income like a bond, but they also incorporate some of the benefits of an ETF structure, such as diversification, liquidity they're exchange listed. So there's a focus right now, and I think that's a byproduct of where the current sort of interest is, and ETF providers are, are kind of showing that they're addressing that need.

Chris Cooksey: Now I'll give you a chance here to predict the future, because that's always fun in this business. What would you expect to see in next year's report, as we are a whole two months in and you get to guess at ten future months of action here?

Luke Kahnert: Yeah, okay, so that's a good question. I don't, no one's got, a crystal ball, of course. But, I think the biggest factor in next year's report is going to be driven by interest rates in some capacity and what I mean by that is the first way interest rates, I think, will affect next year's report, if you will, is we may see the number of ETFs launched decrease due to this higher for longer interest rate environment that is expected. So when a new ETF comes to market, one of the key elements is seed capital. And that seed capital is the initial funding that allows an ETF to launch and become available to investors. When interest rates were low and money was basically free, seed capital was easy to get, and as a result, we saw many ETFs launch. Now, with higher interest rates, the higher funding costs may lead to some challenges for ETF issuers when launching new products, and just as a result of this, I'd expect ETF issuers to be really specific about the types of products they're launching in this new rate environment. The second way interest rates, I think, will affect next year's report is, I touched on this a little bit earlier, but I believe we will see a focus on fixed income strategies, and this is for both mutual funds and ETFs. The reason being is it's been a very long time since rates have been at this level, and there's obviously been, like we had discussed, a lot of innovation within the investment industry. And with that in mind, I think that bond markets are attractive. Again, there's a lot of catch up to maybe to be made within ETF innovation, mutual fund innovation within this asset class.

So that's the second reason. And then the third way that interest rates will affect, I believe will have an impact on next year's report is when we look back over the past decade, specifically, when you look at the data in the IFIC report, I know I mentioned that, you know, you're seeing year over year ETF growth. The consistent theme until recently, is how low rates have been. Moving forward, that that era of low interest rates has passed and one of the things I'm watching is whether active managers will now be in a better position to outperform their counterpart passive strategies.

Chris Cooksey: That makes sense. Now, just one last question, should be an easy one for you to answer. If you were talking to a investing novice, so someone who's just starting to invest, or like I would say my mom someone like that, and they said, Luke, I put my money in, and I buy part of this mutual fund, and then, Luke, I put my money in, I buy part of this ETF, what is the main difference? Because my answer would always be, well, you're buying an actual security when you buy an ETF that trades on the market, whereas when you're buying a mutual fund, yes, it's a group of stocks, but you're buying sort of an investment group or an investment strategy based on what you're looking to achieve, and you don't really own the securities, you buy part of the group that owns the securities. This is, I probably complicated that unnecessarily, but is that basically the, the difference between the two?

Luke Kahnert: Yeah, it's a great question. I think just to put simply, the lines have blurred so much that there may not be a huge difference between the two. Like I mentioned, there are many mutual funds that are now available in an ETF form. And when you look at the two, it really is just a matter of how you want to access the strategy. By buying the ETF, you're buying it over the exchange. So there might be some, some price fluctuations there to consider. And that's where you get into kind of like how efficient the ETF is trading. And a Raymond James advisor can help explain all of that. Whereas a mutual fund trades end of the day NAV. That's the, the biggest difference between the two. And so there, there are pros and cons with going with one route versus the other. But I think you should talk to your advisor about those differences.

Chris Cooksey: Awesome. Well, I want to thank you for taking the time today. Really appreciate it. Always a pleasure to speak with you. And I look forward to your next visit.

Luke Kahnert: Great. Thanks so much for having me, Chris.

Chris Cooksey: Reach out to us at Subscribe to The Advantaged Investor on Apple, Spotify, or wherever you get your podcasts. Please contact your advisor with any questions you have. On behalf of Raymond James and The Advantaged Investor, thank you for taking the time to listen today. Until next time, stay well.

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