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ETF exchange access opening up to mutual fund advisors

By Susan Yellin | January 29 2016 07:00AM

Exchange traded funds (ETFs) are becoming increasingly popular for both mutual fund companies and advisors who see their lower cost, tax efficiency and income benefits as investments their clients can easily use to complement their core portfolios.

BlackRock Inc.’s iShares Canada manages by far the largest share of all ETFs in Canada and there are other ETF-only providers like Horizons Exchange-Traded Funds and Vanguard Investment Management Inc. Other investment firms, including Mackenzie Financial Corp., AGF Management Ltd. and CI Financial were the latest to announce they would be adding ETFs to their mutual fund mix. Most of the banks are already on board, including Bank of Montreal, which is the second-largest player in terms of ETF market share. As of the end of October, there were $86.86 billion in assets in ETFs in Canada.

And there may be more advisors selling the products soon. Advisors licensed under the Investment Industry Regulatory Organization of Canada (IIROC) are easily able to trade ETFs because, unlike mutual funds, ETFs are sold on an exchange. But most advisors licensed with the Mutual Fund Dealers Association of Canada (MFDA) do not yet have access to an exchange to settle the trade.

However, that may change shortly. The Canadian ETF Association (CETFA) and the Federation of Mutual Fund Dealers are working with trade execution provider National Bank Correspondent Network and other IIROC brokers to provide the necessary access to the exchange, said Pat Dunwoody, executive director of CETFA. In addition, the groups are working with software developers so that ETFs can be held as part of clients’ regular accounts for advisors with only an MFDA licence.

New platform

As well, in mid-November, TMX Group announced it was planning to expand its services to extend equities trading and settlement services to the mutual fund industry. The TMX said it had formed a TSX NAVex Working Group, made up of 18 fund and management companies, to help finalize the details of the new platform, which is expected to launch in the second quarter of 2016.

At the same time, the MFDA is looking into ways to ensure that appropriate proficiency standards are in place for its representatives to sell ETFs.

But not only will MFDA advisors themselves have to brush up on the differences, suitability and costs of ETFs, they will probably also find themselves having to teach their clients those very same attributes, sometimes on an ongoing basis.

“I have always chosen to focus on what’s happening inside the fund when talking with clients,” explains Milan Popadich, a fee-based IIROC advisor with Manulife Securities Inc., who began introducing ETFs into clients’ portfolios just before the 2008 financial crisis. “I really present it as giving my client access to certain asset classes. In some cases, I think that ETFs are the better alternative and in other cases I might think mutual funds with their active management are a better alternative.”

Which is better will depend on the client’s need for diversification, whether that’s geography, style or a particular fund manager, he said. ETFs might work better in some markets rather than others, said Popadich, who has about one-third of his book of business in ETFs.

Popadich says that as a CFA charter holder, he is always cognizant of keeping clients costs down and regular ETFs have typically been less expensive than their mutual fund cousins.

Brad Bolton, an IIROC advisor at BMO Nesbitt Burns, is product agnostic, and made the decision to start offering ETFs after the recession in the fall of 2011. Bolton said it was then that he learned about a U.S. index comprising American companies that had increased their dividend payments every year for at least 20 years.

“At that time, the financial crisis was still being keenly felt and we were looking for the kind of companies whose cash flow was so defensive that they were able to increase their dividends even during the recession. So we decided to get clients exposed to a basket of those companies rather than trying to pick individual stocks.”

Bolton said in addition to tax efficiency and lower cost, ETFs can offer hedging opportunities, including those dealing with Canada-vs-U.S. currencies.

Popadich said advisors who have never used the investments before may have to change some pre-conceived ideas.

“A lot of advisors, especially if they come from an insurance background, tend to think of those investment alternatives as products. I think they need to look past the products and understand what kind of exposure the client is actually getting,” he said. “When they do that, I think the differences between the structures are not going to be important.”

He said he will suggest a mutual fund if its active management in a certain asset class is doing a good job, while a lower-cost ETF might work better in a more efficient market, like Canada or the United States.

Bolton said advisors new to ETFs should take a step back and review the literature from the largest ETF providers to get a good understanding of the benefits they provide. “Then,” he said, “take a further step back and see what needs your clients have that can meet what’s in an ETF.”

Dunwoody suggested that some advisors might want to start out by putting 10 or 15 of their best clients in ETFs, perhaps on a fee-based basis.

Investors who like simplicity and want to monitor their ETFs can easily do so by following the index. Because of the nature of the Canadian market place, which is heavily tilted to financials and energy stocks, many people own mutual fund portfolios that actually contain the same stocks. But if an investor wants to purchase the TSX60 index, for example, they are going to get the same stocks no matter which provider they go to, said Dunwoody.

More income

Bolton said there are ETFs today that can provide more income than an investor would otherwise get by investing in the underlying index. “So, for example, I can invest in an ETF index of Canadian banks through an ETF, or I can invest in almost the same index using a covered call strategy to produce more income. So while the yield on the banking sector might be 4.2%, an ETF that has a covered call strategy can provide an income in the range of 5%-5.5%.”

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