Advisors can now catch ETF wave with hybrid product

By Ian Bolduc | January 12 2010 04:31PM

Invesco Trimark's launch of PowerShares has opened a potentially lucrative market for financial advisors. Thanks to this product, MFDA-licensed advisors can now offer their clients an investment that consists of one exchange traded fund. If PowerShares are successful, the trend may extend throughout the mutual fund industry, and perhaps into segregated funds as well.

Recently introduced to Canada by Invesco Trimark, PowerShares funds are a unique offering in the country's mutual fund industry. Each PowerShare is a mutual fund wrapper into which an exchange traded fund (ETF) has been inserted. Normally these ETFs can only be sold by fully licensed securities representatives, but they are now available to advisors in the mutual fund channel.

According to Gordon Pape, Editor and Publisher, Mutual Funds Update and a columnist for The Insurance and Investment Journal, this is the primary advantage of PowerShares for mutual fund representatives. It allows them to offer ETFs to their clients. "I think that the idea behind this product is to provide an alternative solution to advisors who cannot sell exchange traded funds directly," he says.

Sandeep Gosal, an analyst at Investor Economics, points out another advantage. Because PowerShares are mutual funds, Invesco Trimark pays a trailer fee to representatives after the sale. Exchange traded fund providers, on the other hand, do not normally pay trailers to securities licensed advisors. "As a general rule, exchange traded funds don't pay a trailer fee, although there are a few exceptions, such as Claymore," he notes.

Normand Morin, Chief Executive Officer of Investissement Excel, responds positively to the launch of Invesco Trimark's new product. "PowerShare funds are a little different from true exchange traded funds because of the additional mutual fund wrapper, but they are fairly close, and that will probably satisfy clients," he says.

"We applaud what Invesco Trimark has just done, and we believe that it is very good for advisors to have more tools for their clients," says Robert Frances, President and CEO of Peak Financial Group.
This new product has a great deal of potential. It remains to be seen if the public will follow and buy it," comments Mr. Pape.

Setting a trend

If Invesco Trimark is successful with its PowerShares, experts interviewed by The Insurance and Investment Journal believe that more mutual fund firms may eventually bring similar types of products to market.

"It will be like all other new products. If competitors see that there is a keen interest, they will certainly try to offer the same type of product as well. The competition will be watching," says Mr. Morin. He believes it would be good for advisors to have more than one product provider.

Mr. Pape agrees. "I am sure that mutual fund companies will carefully analyze the results obtained by Invesco Trimark. If PowerShares are successful, there will be imitators. But if it's a fiasco, everyone will say, ‘What a lousy idea that was!'"

The Insurance and Investment Journal contacted a number of mutual fund companies, including Franklin Templeton, Fidelity, AGF, and Dynamic Funds (DundeeWealth), but they all declined to comment on the subject.

Before talking about a new trend, it remains to be seen what kind of popularity this product will have in the market. According to Mr. Pape, it will depend on the success Invesco Trimark has in selling this concept to advisors, and then the success the advisors have doing the same with their clients.

Consumers' enthusiasm for ETFs shows no signs of abating. "The numbers indicate that the growth in assets under management by exchange traded funds is much stronger than that of mutual funds," says Mr. Pape. According to data collected by Investor Economics, ETF assets increased by 43.7% between January and October 2009. During the same period, the Investment Funds Institute of Canada (IFIC) reported that assets in the mutual fund industry only grew by 13%. In 2008, exchange traded funds grew by nearly 8% compared to the previous year, but mutual funds lost 27.3% during the same period.

Heather Pelant, head of iShares at BlackRock (formerly Barclays Global Investors) also notes that ETFs are gaining favour with consumers at the expense of mutual funds. She suggests that, more and more, exchange traded funds are gaining the upper hand over mutual funds. When people begin to invest in the stock market again, she believes that they will choose to do so through ETFs.

Som Seif, President and CEO of Claymore Investments in Canada, is of the same opinion. "We see that consumers are gaining a better understanding of exchange traded funds. More and more, they know that they are available," he comments.

Mr. Pape notes that despite the strong growth experienced by exchange traded funds, mutual funds still lead in Canada in terms of total amount of invested assets. "They will stay there for a long time, perhaps forever," he says. According to data compiled by IFIC, total assets under management by mutual funds reached $573 billion at the end of October 2009. Exchange traded funds reached $27.7 billion at the same date.

It was not possible to obtain sales figures for exchange traded funds since they trade directly on the stock exchange.

If a mutual fund allows an advisor to sell an ETF, a segregated fund could play the same role for an insurance licensed advisor. Is it likely that an insurer could launch a segregated fund that only invests in a single exchange traded fund?

"It is possible. The insurance companies already offer mutual funds by way of segregated funds. Nothing prevents them from doing the same thing with an exchange traded fund. It is the same principle. You create a segregated fund and the underlying product is an exchange traded fund," explains Mr. Pape.

Desjardins Financial Security (DSF) admits that it is thinking about it. "It is an option that we are considering. It would allow us to reduce our fees," commented Claude Paré, Senior Director of product development and marketing. He said he believes this kind of product could be attractive, since most money managers have trouble beating their benchmark index. However, Mr. Paré emphasized that DFS still wants to offer actively managed products.

Manulife Financial simply stated that it is constantly re-evaluating its product line-up in order to offer a wider range of choices. The other insurers contacted by The Insurance and Investment Journal, namely Great-West Life, Sun Life Financial, Industrial Alliance, and Standard Life, declined to answer questions on the subject.

Mr. Frances of Peak finds the idea to be an interesting one. "Being the president of an advisory firm, I like to see as many options as possible for advisors." Nevertheless, he believes the product would be fairly sophisticated and could be expensive, given the guarantees and other characteristics of segregated funds.

Mr. Morin of Excel also sees value in the idea, as the management fees of exchange traded funds are lower than mutual funds. On the other hand, Mr. Morin points out that insurance advisors may be less inclined than mutual fund advisors to offer this type of product. "Insurance advisors are often less interested in investment solutions. They sell life insurance primarily, and segregated funds are more of a complement to their services," he says.

Really new?

While some say that Invesco Trimark's PowerShares are a first in Canada, others say that the product is nothing new.

"Several mutual funds hold exchange traded funds in their portfolios and their managers have been using them for years. So I don't really know what Invesco Trimark is trying to do. Apart from being able to say that PowerShares allows access to a dollar cost averaging program, I don't understand how a client could benefit from this product," says Ms. Pelant of BlackRock.

Claymore agrees. "It's not new. Almost all mutual funds invest in exchange traded funds up to some point," says Mr. Seif. He points to AGF, JovFunds and QTrade (Ocean Rock) as examples.

Most mutual funds distributed in Canada can invest part of their portfolios in ETFs. "At the moment, a large number of mutual funds invest a portion of their assets in exchange traded funds, but it is often just a small part of the whole, 5% for example," explains Mr. Gosal of Investor Economics. He adds that this passively managed portion serves to reduce the fund's management expenses. "Also, it can sometimes be difficult to obtain exposure in certain specialized asset categories. So exchange traded funds can be a solution for the fund manager."

While Invesco Trimark is certainly not reinventing the wheel, the company is venturing into new territory, since the mutual fund's assets are entirely invested in one exchange traded fund. "Sure, several mutual funds are already investing in exchange traded funds, but it is the first time that we are seeing what Invesco Trimark is doing," notes Mr. Pape.


For Mr. Frances, the fact that mutual fund representatives could sell a fund that invests exclusively in an ETF concerns him in one regard. "From a compliance point of view, a mutual fund advisor obviously does not have the right to advise a client about an exchange traded fund. It's very delicate, because it is not always clear to the client," he says.

Mr. Frances is concerned that the consumer might think he holds an ETF when in fact he really owns a mutual fund.
The Quebec regulator, the Autorité des marchés financiers (AMF), does not see any potential problems with PowerShares. As is the case with most pooled investments, the AMF points out that mutual fund advisors sell funds that invest in shares, and the advisor does not have a license to sell those shares directly. Sylvain Théberge, a spokesperson with the AMF, notes that in this respect, a fund that invests in one or several ETFs is similar to one that buys stocks.

Mr. Frances believes that an advisor must make sure he clearly explains the nature and characteristics of this new product to clients before selling them. "If, two years after buying PowerShares, a client complains to the authorities, saying that his advisor recommended an exchange traded fund when he only held a mutual fund license, will that be a legal infraction?" wonders Mr. Frances.

Mr. Théberge explains that because PowerShares are a mutual fund, the client can not make a future complaint based on the fact that the representative did not have the necessary license to sell ETFs. "In this case, what is sold is a mutual fund, and not an exchange traded fund," he says.