MASTERCLASS: Liquid Alts
April 1, 2019
Clare O’Hara: Although 2018 was a challenging year for investors and the market as a whole, ETFs brought in over $20.1 billion in net sales for the year. It marked a pivotal moment in the industry as ETFs outsold mutual funds for the first time since 2009. The shift comes after five years of dominant mutual fund sales where some investors put in more than three times the amount of money into mutual funds versus ETFs. 2018 however, has reversed that trend and we are now looking at ETFs becoming the investment choice for Canadians.
Clare O’Hara: Today in our master class, we're going to explore exchange traded funds and their place in the Canadian landscape. To lead us through this discussion we have Steve Hawkins, President and CEO at Horizon ETFs. Andres Rincon, Director of Equity Derivatives and ETF Strategy at TD Securities, and Michael Cooke, Senior Vice President and Head of Exchange Traded Funds and Mackenzie Investments.
Clare O’Hara: Good morning everybody. [crosstalk 00:01:04].
Clare O’Hara: Steve, let's begin with you, index ETFs in both the U.S. and Canada continue to see their fees decline. In your company you've actually launched zero fee funds, but how low can ETF fees go and how can ETF providers actually generate revenue in this environment?
Steve Hawkins: Very good question. We have to thank ETFs generally though as Canadian investors for bringing fees down. 10 years ago mutual funds, the average MERs were over 2% and now we have ETFs with very small basis basis point management fees. We're going to continue to see fee compression. It is a race to zero for all intents and purposes. We're going to see a continued competition in the ETF space. We're going to see more and more providers, now we have every Canadian bank and every large asset manager now entered the space. There's over 36 providers, I think Andres says there's 37, I only think there's 36. But we're going to continue to see more fee compression, we're going to continue to see more product. But in this space is really is coming out with unique product. When you have Marquis products that are differentiated, innovated, different, we don't need another SMP 500 ETF at 8 basis points or 9 basis points, but when you come up with something a little bit different from an idea perspective you can charge more for that.
Steve Hawkins: As an independent ETF provider we are really looking to continue to innovate, create new ideas. Until competition really catches up and matches you from a product strategy perspective we can continue to charge fees based on the Marquis brand of an ETF.
Clare O’Hara: All right, Andres, how much is price factored in when clients or advisors are actually looking at these products?
Andres Rincon: Prices in fees?
Clare O’Hara: In ETFs, when they're looking at ETFs, how often do they actually pay attention to what the cost is?
Andres Rincon: Quite often. It depends really on the product. As Steve alluded to, if you're looking let's say at a passive ETF that has [inaudible 00:03:11] replication across different providers, in cost it would be very, very important, not just in management fee but also, the trading expense ratio and different costs that the ETFs incurs. It's very, very important for the advisors.
Andres Rincon: You also have spreads, for example, amongst other factors that advisors look at when it comes to passive ETFs. But when it comes to say an active ETF, they will look a lot at performance because at the end of the day, these ETFs sometimes would trade with larger spreads and tend to cost a little bit more because they have a specific expertise that they're going towards, and performance is very important. Cost is very relevant on the passive space, it would be less, I would say, on the active side.
Clare O’Hara: Right, Michael, coming from someone who has the active side as a mutual fund provider, how are you setting up your fees in the ETF world?
Michael Cooke: Well it's a good question Claire. I think you look at the value that's being delivered, in the form of an active strategy where there's fundamental analysis, market analysis, that warrants a different pricing proposition. I would argue that the race to zero is a little bit overblown because if you can't cover your cost as an ETF manufacturer, an asset manager, it's going to stifle innovation, it's going to stifle choice and creativity for the industry. I think the market participants understand that, advisors, investors understand that as well. Certainly, there's fee pressure and that's probably a good thing. But this notion that we're going to zero in certain segments of the market I think is a little bit overblown.
Michael Cooke: Just to build on Andres' point, even in commoditized segments like passive, you have to look at things like tracking error. You have to look at spread costs, you have to look at things like withholding taxes or tax efficiency. What the investor experience is going to be is a by-product of that. In terms of the most successful products in the ETF market today, they're not necessarily the cheapest. They are efficient, they are generally liquid, and they provide the desired exposures to different investor segments, but it's not necessarily just about the headline management fee. I think that as you go through and dissect the different segments within the ETF market from traditional index or passive exposure to strategic beta, which shares characteristics of both active and passive. Then, of course, the more traditional fundamental active. They all warrant different price points because they deliver different sources of value to the investor. We don't want to use one frame of reference when we're looking at the relative cost of different solutions, and I think it's just indicative too of the growing breadth of choices that we have now in the ETF market in Canada.
Clare O’Hara: Right. Just to stay with you for a second Michael, when we look at the ETF flows from 2018, what conclusions can we draw when it comes to things like investor sentiment, and market conditions, what are you taking away from that?
Michael Cooke: Well, the mutual fund industry is obviously a little more mature and is much larger in Canada. Gross sales in the mutual fund industry in Canada in 2018 were still very, very healthy. Redemption pressures rose a little bit and that led to the relative out-performance on a net sales basis of ETFs versus mutual funds. I'm an ETF guy and I love the attributes and the benefits of ETFs, but mutual funds offer a different value for different investor segments. There are things that a mutual fund offers that an ETF does not, and vice versa. I don't think it's an either/or narrative, or heralding the demise of one industry versus another. ETFs are broadening their relevance against a backdrop of fee compression and fee pressure certainly are becoming more relevant. But you also look at the broad appeal that ETFs hold. You have advised retail client segments, you have the do-it-yourself channels, you have emerging channels such as robo-adversary, then you have institutional that are meeting in the ETF space and are using the same products. It's arguably a broader segment of client tiers that are contributing to the growing demand of ETFs, but I think there's a place for different investment fund vehicles in the marketplace in 2019 and beyond.
Clare O’Hara: Andres, what are your thoughts on when we're looking at flows?
Andres Rincon: Well first thing to notice is that despite a tough year, as you mentioned, ETFs still have quite a bit of inflows, which this gives the idea that the market's very strong and there's still quite a bit of demand for ETFs. But when we drill into some of the flows for last year for example, what we can see is that a lot of the active strategies have really seen a lot of the inflows in a year over year growth basis, let's say. Custom indexing strategies and fundamentally active strategies have seen quite a bit of growth over the last few years to the tune of 40-43% in the case of those 2.
Andres Rincon: We've also seen the likes of asset location ETFs have grown massively. Obviously, Horizons has a couple and you have MPCF on your side. We've seen a lot of growth in that space and we think we're going to get more growth in the coming years.
Andres Rincon: Last but not least, the manic ETFs, despite their volatility enters a flow sometimes that we've seen quite a bit of growth in thematic ETFs and we think that space will continue this year.
Clare O’Hara: Steve, you do have thematic, you have asset allocation, you have active ETFs, where's the migration occurring for you guys?
Steve Hawkins:We're really seeing more users come to ETFs. To Michael's point, ETFs have really brought the entire investment gamut of people who are out there using it from self-directed, to the retail advisor, to the institutional investors, you don't see that in mutual funds. There are not a lot of institutional investors that are using mutual funds, I can't think of any actually. Mutual funds are institutional investors and they're using ETFs now, so we're getting more and more usage out there from the institutional, from the retail, and from the self-directed investor themselves. But we're going to continue to see flows in that space. There are 800 plus ETFs now, we're seeing more and more investors come in into the asset allocation programs, as Andres mentioned. We've seen several launches this year from the big product producers out there in that space. But we're just seeing a general, strong trend to using ETFs generally. There's a lot of noise out there because there's a lot of providers, there's a lot of product. But there's several 1,000 mutual funds in Canada and why can't there be just as many ETFs?
Steve Hawkins:To Michael's point, I actually believe that ETFs can almost do every single thing that a mutual fund can. There is very, very few asset classes that ETFs cannot access the same way. ETF is a liquidity provider for different asset classes, different sectors. That's why we've seen a huge flow in fixed income ETFs from the retail side last year and we're going to continue to see that, and that's where we've seen the outflows out of the mutual funds because ETFs, especially active ETFs, more than 50% of the ETFs being launched now are active and they're primarily dedicated to the fixed income space because that's where we can see really added value over true active investing relative to the equity side where it's primarily more passive.
Andres Rincon: A lot of our advisors have gone that way where they don't necessarily want to manage single positions and bonds anymore, single position, the preferred market anymore. They'll go the route of going with ETFs, and that's what's driven a lot of the demand for fixed income ETFs. I think we'll be one of the fastest growing areas in Canada.
Clare O’Hara: 2018 was a phenomenal year for ETFs, but they still dwarf mutual funds, so Steve, what do you think has to happen for that continued growth, for investors to actually start to have that shift away from mutual funds into ETFs, or to have portfolios that are maybe a bit more split?
Steve Hawkins: Canadians have always been mutual fund users. We're like the biggest mutual fund users in the world on a relative basis, and we always lag what's going on, especially in the United States, from a change perspective in this industry. We are now seeing ETFs in the U.S. take over mutual funds. We're seeing huge in-flows ETFs, and huge out-flows out of mutual funds.
Steve Hawkins: In Canada, with 2018, we saw that nice shift for us from an ETF provider. Flows overall were down significantly because there was a lot of market unrest last year. There was a lot of noise that was out there. We had no idea what was going on with Trump. We have no idea what's going on with China, and all of these things it impacted the market significantly. December, nobody liked December, especially us ETF providers who saw our AUM drop significantly. We make money when investors make money, as AUMs go up we make more management fees. We're invested just alongside the investors in that regard.
Steve Hawkins: But for us from a shift perspective, it's going to happen, when it happens I don't know. I think it's probably, maybe a 10 year mark from here to see a full takeover of ETFs over mutual funds. But as generations progress, the older generation who is retiring, they have wealth, it's being inherited by the millennials who are now ETF users. That old money to new money is really shifting hands. We're seeing the uprise of robo-advisors, of asset allocation plays, and we're going to continue to see, from my perspective, redemptions in mutual funds and sales of ETFs. That's why we're an ETF only provider.
Clare O’Hara: Andres, you're saying there's 36-37 ETF providers, what do they have to do for this continued growth as individual firms?
Andres Rincon: I think it's two-fold, it's really finding the gaps in the market when it comes to product that's not there yet. As Steve mentioned, there's a whole slew of mutual funds still out there, so I think there's a lot of product that can still be had in the ETF space, in the active side. But it's also about sales, it takes a long time to have the sales force that you once had in mutual fund land and have now in ETF land to talk in an educated manner to advisors about ETFs. I think that transition will happen over time and I think that's one of the key characteristics, and when I look at provider that's successful, they have staff that is very well versed in ETFs, which drives the growth of that provider. I think as more and more providers come in it will become more and more relevant how good your distribution is.
Clare O’Hara: Michael, where do you think the growth is going to come from?
Michael Cooke: Well it's interesting, as the industry evolves and matures, so too do investors, whether they're financial advisors, do-it-yourself investors, institutional investors, and I think investors are looking for more customization. They want a particular outcome as investors. As important as relative performance is, it's also about what am I trying to achieve as an individual investor, my particular appetite for risk, or perhaps I need a certain income stream, or other objective. What's interesting about ETFs is that they're becoming so versatile and useful as building blocks to build better outcomes and portfolios. We've talked a little bit about asset allocation ETFs that do all of that for you. I think that's an important growth vector for the industry, but also, mutual funds and other investment vehicles, pension funds that are seeing the benefits for asset allocation purposes of using certain ETFs, asset allocation matters greatly for investors, it's aligned with that quest for certain outcomes and you can achieve a very efficient asset mix cost-effectively with ample liquidity and transparency to build better outcomes and portfolios. That's where I see a cross-pollination between mutual funds and ETFs.
Michael Cooke: To the earlier points though, it is a world where fees are generally lower and we talk about that at length about what fee pressures mean. Among other things, it means you need a scale strategy if you're going to be viable, if you're going to cover your expenses as an asset manager going forward. If you're a new entrant into the ETF market you better have a strategy to scale your product because you're playing in a sandbox that is much more fee sensitive, much more competitive, and you have to demonstrate to the marketplace too that you're committed, that you're bringing relevant solutions, that you have a scale strategy, that you're supporting education. If you're not checking those boxes it's going to be hard for newer entrants to succeed in this environment.
Steve Hawkins: The one other big thing that's going to help make this shift is the fact that now all of the big banks and all of the big asset management companies themselves are launching ETFs. They're not launching mutual funds anymore, they're launching more and more ETFs and that is really going to help [inaudible 00:15:53] with their distribution channels, as Andres pointed out. They own the distribution in Canada, there's no if, ands, or buts about that. We are also selling into that channel, but once they put their shoulders behind selling ETFs rather than selling mutual funds anymore, we're going to see a continued large swing in ETF flows versus mutual fund flows.
Clare O’Hara: When you know that all the big banks are coming in and we're just talking about asset allocation ETFs, do you anticipate everyone's going to have that product, it's just going to be no different then an index fund that everyone will have an asset allocation fund on their product shelf?
Steve Hawkins: Honestly, I truly believe that is going to happen. It's very difficult though for these large asset management companies when every one of them has a passive pool of assets that they have to invest. It's very difficult for them to use somebody else's ETF. You don't see RBC Asset Management using BMO S&P 500 ETF, they're going to come up with their own ETF, and invest their own dollars, why are they paying BMO when they can earn those revenues internally themselves? Because they have the scale, because they have those assets under management they can easily bring those ETFs to scale to be profitable and not pay somebody else to manage that money, and they can use their own resources, as Michael was saying.
Steve Hawkins: All of these asset management companies out there that have bene traditionally doing mutual funds have the infrastructure to manage ETFs. It's almost like the flicking of a switch for them to launch a new ETF on a new asset class. We don't need another S&P 500 ETF, but there's going to be more of them out there.
Michael Cooke: You take the building blocks and you populate them into the strategy, the top fund, we have to be very mindful of among other things, complexity and cost. If you're not an at-scale ETF provider and you're using somebody else's building blocks you're incurring additional cost that's ultimately being absorbed by the end investor. Ideally, you have as many of these building blocks at your disposal, you can manage cost more effectively, you're manufacturing in-house, you're not out-sourcing, so to speak.
Michael Cooke: I think increasingly the market is paying attention to the total cost of investment and generally speaking, ETFs are more transparent in disclosing that those total costs from management fees to spread costs or other transaction-related expenses. You want to make sure you have a buttoned down strategy. I think as well, we might talk about it later in the program Claire, but I think there's also limits to the scope of innovation you want to build into an ETF. There are operational constraints, there are liquidity constraints, but there's also explanatory constraints, if you will. Generally, ETFs are fairly straightforward and intuitive to the investor. Of course, we all think about innovation every day, but you also want to make sure that your innovation is aligned with the needs of the end investor and that's where I think we have to be mindful as manufacturers of what the end-market's looking for.
Andres Rincon: That's a good point in the case of asset allocation ETFs. If you're not constructing that ETFs with other of your own ETFs then it becomes very expensive and you're not competitive really to what's on the street. It's very important to have a low cost structure with those specific ETFs.
Clare O’Hara: Right, because it just goes right back to the whole pricing-
Andres Rincon: Exactly.
Clare O’Hara: ... question. My next question is for all three of you, I just want to know where do ETFs fit into this volatile market? Maybe Andres you want to start us off?
Andres Rincon: Actually, we have a plethora of ETFs these days and there's many ways in how you can get into or invest in a low vol environment using ETFs. We have, for example, low volatility ETFs. In many cases, each provider will have a different way to see that or to invest in that, but you also have sector ETFs to low volatility sectors, so you have healthcare, [REET 00:19:39], utilities ETFs, for example. The average investor can go in and invest in those sectors that are low ball. You also have [inaudible 00:19:45] writing ETFs. [inaudible 00:19:47] writing ETFs tend to lower the volatility of other portfolios so they're great in a volatile environment. In combination with all these three strategies you can say ... Oh, I'm sorry, before I go on, you have fixed income ETFs. At the end of the day, if you see a volatile market in equities you can say well I'm going to par it back and go into a cashed ETF or some sort of fixed income ETF. There's many ways that an investor can a low vol environment using ETFs.
Michael Cooke: I think the efficiency of ETFs that we've discussed, in a risk off market like we saw in December where, among other things, there was concern about where our interest rates were going, you can de-risk a portfolio very efficiently and effectively by looking at an ultra-short duration fixed income ETF or a floating rate ETF that gives you instant diversified exposure and can help insulate a portfolio. Generally speaking, a broad-based equity ETF is going to be correlated with the systematic risk of the underlying market, as with any other investment vehicle. But it's the efficiency, I think, of exchange rate of products that can help you pivot, adapt a portfolio on a level that institutional investors have been doing for decades, but now through the efficiency and the single ticket exposure afforded you as an ETF user, you can slice and dice the market any way you see fit.
Michael Cooke: We don't talk too much about inflation in the current environment, but there are also solutions in that segment that can help insulate a portfolio. Some might argue an all weather portfolio has got exposure to each of the different risk buckets because you never know if it's going to snow or rain tomorrow, the sun's going to come out. I think it's probably going to snow. You just want to have that all-weather solution and I think ETFs give you that flexibility to really build a well diversed ripe portfolio through all market conditions.
Steve Hawkins:We really believe that Alpha and how Alpha's generated now by the end user or by retail advisors is really changing. This world is shifting away from single stock picking, single bond picking. Individual securities are really the old school way of thinking when it comes to managing people's portfolios now. People are looking for simple liquid exposure to different asset classes, and ETFs have really provided, as Michael was saying, a very efficient vehicle and way to access all different types of strategies that they can employ very, very quickly, very, very easily through one ticket. One trade is a very, very simple way to get out of fixed income and into equities.
Steve Hawkins: Investors who don't stay the course typically always buy at the high and sell at the low, and unfortunately, that is the way it is when people put their investment biases over managing the way they manage the money. But we really are hoping that more and more investment tools out there, more ETFs, from a product perspective, will just continue to allow investors to make more decisions. Education is extremely important in this world and we're going to continue to see more and more ETFs come out with more different strategies that will allow investors to make more educated decisions with respect to how things are done.
Steve Hawkins: But ETFs are still really sold, they're not bought. There's not a lot of investors out there that are just doing all of the homework themselves anymore, they need to be told a story. They need to understand what the outcome is, that it is from that investment strategy that they're putting their money into. From that, we're going to see continued ETF usage.
Clare O’Hara: When we're talking about sales, and this was always a number that I find tricky to dig into when I'm reporting, but how much of it is really coming from institutional sales versus retail sales? Where are the flows?
Steve Hawkins: The market has shifted completely in Canada anyway from ETF users. 20 years ago it was 80% institutional and very slightly retail and self-directed from that perspective. Now, the big tickets are still really institutional from an asset management perspective, but from our ETF lineup we've seen a really big shift from institutional, to retail advisor, and to self-directed users themselves. Our lineup is probably a third, a third, a third now, whereas, it used to be traditionally 90% institutional, so seeing a huge shift over the past 10 years in the users. I think a lot of that also is the shift from the retail advisors who aren't buying mutual funds anymore, they're buying ETFs because they are providing [inaudible 00:24:20] day liquidity, they're simple, efficient transactions. They know the costs, very simply, and generally speaking, management fees are lower than mutual funds. This marketplace is all about making money for your clients and if you are paying lower management fees on the products that you're investing them in you already have a head start of how much money you're going to be making them.
Clare O’Hara: Michael, what are you seeing?
Michael Cooke: I think if we were having this conversation five years ago it would have varied by product type, so institutions would have a particular preference for a certain type of exposure, say traditional index. But today, it's a very different narrative. I think as the market has evolved there's more choice, you have competitive fees across a number of product categories such that investors of all stripes are looking at the entire spectrum and saying there's a gap in my portfolio, this is a very efficient, cost-effective liquid way to fill that gap, I'm going to use this solution. It's still early days because the ETF industry is still in its nascency, but more and more investors across all the client segments are availing of the full spectrum of products. We have an active solution in the floating rate loan space that is now starting to be used by institutional investors that see the appeal of active management in the asset class. They like the liquidity of our ETF, they like the price point. It has appeal to both institutional and retail investors in this regard, and I think you'll continue to see a blurring of those lines as the industry matures, as more ETF users enter the marketplace and see the value across the entire spectrum of now 800 plus products that we have in the Canadian market.
Andres Rincon: As a market maker of ETS, we see the flow actually from all three areas. We see it from mom and pop in retail. We see it from advisors and we see it from institutional. If you look at a chart of it all three actually have gone up quite substantially. What we're having is the education of retail investors about ETFs, so they're getting to know them through trading them more often. You also have advisors, and I think with regards to advisors, I think active management in ETF has played a huge role and we're seeing a lot of the advisors that used to invest in mutual funds now invest also in ETFs. Institutional investors continue to use ETFs in Canada, but now what we're seeing is many of these ETFs trade more and more in Canada we're seeing a lot of the institutional managers in Canada becoming more comfortable Canadian ETFs and trading them more often.
Clare O’Hara: Just talking about passive and active strategies, and maybe Steve to throw the question your way, are there certain asset classes or strategies that work better with one actively or passive?
Steve Hawkins: Traditionally yes. We've seen this for a long time. There's a lot of different studies out there in that regard. Investors have really taken hold of passive equity, maybe some strategic beta in there, some themes in there, but we've seen a huge shift of investors into passive equity, as opposed to fixed income where traditionally it's been very difficult for active managers to beat equity indices. It's been relatively easy for active fixed income investors to beat indices. There are more indices in the world than there are stocks listed, and a lot of those are fixed income, but fixed income is very, very inefficient from an investing perspective. It's very, very difficult for ETF providers to replicate a fixed income index. You're dealing with liquid or very illiquid underlying securities, generally speaking, so there's always some strategic sampling.
Steve Hawkins: There's always some discretion that is going to managing fixed income products, so why not just invest in active who really can take advantage of the inefficiencies of index investing and where we have traditionally been able to continue to see returns. Preferred shares, we run HPR, the active preferred share, ETF, it's the largest active preferred share ETF in Canada. It's almost the same size as the largest index preferred share ETF. Traditionally, we charge maybe 10 basis points more for active management over passive in these types of spaces, but we've been able to deliver on average about a 100 basis points of out-performance after fees on a year in, year out basis. When you have that history of being able to outperform traditional beta, then why not invest in active strategy? That's the exact opposite for equities. It's been very, very difficult for active equity investors to beat the TS 660 or beat the S&P 500 on a year end and year out basis. There are a few, but on an overall basis we see roughly 80% of active fixed income investors beating indices where it's the exact opposite for equities, so only 20% of active equity investors can beat the equity indices.
Clare O’Hara: Andres, what are you seeing when it comes to product launches or what you're seeing being introduced into the market? Is there more active coming out, especially in Canada?
Andres Rincon: Definitely active, disclosure rules in Canada, which are quite different in the U.S., incentivizes a lot of the providers to launch a lot of fixed income and active products in general, so we do see quite a bit of active product in Canada. I think also as the other banks round out their lineup you're going to see grow of some of the passive products that they need to compliment their lineup, but active is in the area where we're going to see the most amount of growth.
Andres Rincon: Back to this point, some of the inefficiencies that exist in the [inaudible 00:30:23] market, in the bond market, you can also say that about some equity markets, such as real estate or healthcare, some areas that you're going to have specialized expertise from some managers where you can see where active has become very popular. I think those areas will continue to grow in Canada.
Clare O’Hara: Are advisors looking for things like healthcare, they're looking for ones that break out in that in an active space?
Andres Rincon: For sure. It's funny, there's I think, maybe I'm going to get this wrong, but there's about seven or eight, eight with the new one that just launched, healthcare ETFs in Canada and four or five of those are... writing ETFs, so there's definitely a niche there that I would say doesn't happen in the U.S., for example. There's quite a bit of reach ETF in Canada just because generally you go to specialized providers who have a focus on that.
Clare O’Hara: Great. Michael, what are you seeing?
Michael Cooke: Definitely there's more issuance of active products. As has been discussed, active management tends to be very highly correlated and work most effectively when you have less efficiency, so a more complex market, a less liquid market, a market that's more heavily trafficked by institutional investors where retail access is more limited. That's where active management can have tremendous value and that's where we've led ... Steve talked about active fixed income as a great example. It's not the only one, if you have a high conviction equity portfolio and an equity manager with a long-term track record that can lend well to the ETF structure itself.
Michael Cooke: But you just want to be mindful of what gaps are you trying to fill in the marketplace. If it is one of those strategies in a less efficient market, or active management can add tremendous value, you have a reasonable price point, you have a liquid solution, and you provide the desired exposure to a segment of investors that's a recipe for success. I think you'll continue to see duplication of certain strategies in the marketplace. We talked about healthcare, we talked about rates, even more passive product issuance. It just gives the marketplace more choice and it keeps honest the larger incumbents. They may be first movers, but they don't necessarily have the best mousetrap. They may be the largest product, but that's not always how the industry's going to look 10 years from now.
Michael Cooke: If you think you've got a compelling value proposition, you've got a strategy to scale your business, and you've got a relevant message to the marketplace there's lots of rooms for issuers in this market. It's just it's very different from other segments of the asset management industry and you just need to have a dedicated strategy.
Clare O’Hara: When we see things like duplication and different firms launching their own index products, how does an advisor sift through all that, with all the product that's now sitting there, and I know it's not much as mutual funds, but where do they start?
Michael Cooke: That's a very good question. Ideally, you want products that have a little bit of seasoning, even passive products require some seasoning so investors can make an informed decision about how efficiently they're tracking their benchmark, how tight is their tracking error, what is their total expense ratio. That's hard to glean in the first few weeks or even months after which an ETF is launched, so a little bit of seasoning, some education as to how these products use ... There's certain segments of the ETF markets, admittedly, that are commoditized, but you can differentiate yourself in talking to your clientele about how to use these products, how to affect better outcomes for the financial advisor, for their client, for the institutional investor. A lot of it is education in a more commoditized world that we see in certain segments of the ETF market. You have to be visible, you have to be communicative, you have to be educational. You have to put the client's interests first and if you're doing that you're going to succeed.
Clare O’Hara: Andres, do you have any advise on where they can start?
Andres Rincon: I think I will mirror a lot of things that he said if I'm honest. Two things that I think are important despite there's a lot of competition with a specific product, I think it's important to know the manager, know who you're dealing with. I think in spite of being a pure passive product, if you know that somebody has been doing this product in mutual fund form, let's say for some time, it's important to know how they operate. Also, securities lending, some of the little things here and there that may generate that ETF even more revenue that makes the ETF cheaper or perform a bit better. When it comes to pure passive product, you have to sometimes dig in a bit more compared to when you have an active product where you care about performance quite a bit.
Clare O’Hara: Steve, what are your thoughts, do you think there's too much product out there and other certain areas that you steer clear of?
Steve Hawkins: Absolutely. There is too much product. There is too much obligation now on the investor who has to understand what it is they're buying. I don't think that's going to change and I think there's going to be more and more product, especially as the biggest asset managers and banks put their shoulders more behind ETFs. But nowadays, especially with investment advisors who control a significant amount of the wealth in Canada from an investing perspective, their fiduciary obligation now includes know your product, so they have a very specific regulatory obligation to understand the product that they're investing their clients into. It takes a lot of information to be able to get that and they have to do a lot of comparisons out there.
Steve Hawkins: There are great ETF analysts like Andres out there who can provide lists of all 800 ETFs and they have them broken down by each of the different asset classes. They do great comparables on fees and performance, tracking error, all in cost when it comes to the efficiency of trading these different products, but all of these factors and yield, as he was saying, from security's lending, all of these different factors go into understanding the product itself.
Steve Hawkins: The self-directed investor, at the end of the day, they really haven't spent a lot of time. They don't read [inaudible 00:36:22], it's, from my perspective, a useless regulatory document. We were required to create, very specific with respect to the objectives and strategies of those different ETFs. The investment advisors do have an obligation to understand those facts and now we have what's called a fun fact document, which is a little bit simpler, it's one page front and back. We have to file those every single time we file file the perspectives and those are very, very important quick and direct descriptions of what is going on with ETF, and understanding all of the different facts, as Michael was saying, seasoning is very important with respect to an ETF.
Steve Hawkins: You don't see a lot of ETFs right out of the gate do extremely well from an asset gathering perspective unless it's within an asset management company and they're just shifting assets from somebody else's ETFs into their own ETFs, and we've seen a lot of that over the past couple of years with new products that are launched, so giving them some nice scale immediately. But we're going to continue to see a stronger know your product obligation out there. We're going to continue to try and educate the public more on ETFs. I like all of the different providers. I like all of the different ETFs. There's a lot of noise out there, but it does help you stand out when you have differentiated and innovative product out there, and you have a very specific story that you want to tell.
Clare O’Hara: Just following on this is going to be the first year that all the Canadian banks are either in or about to launch their strategies. Most of the largest asset managers are now in the game. This will be the first year to see what's going to happen. How does a small firm, not that any of you are from a small firm, but maybe even on the independent side, how do you compete with the banks?
Steve Hawkins: It's a continued differentiated product, doing something different. Horizons is not the Walmart of ETFs. You can go to some place else and get a very simple physical replication, S&P 500 or TSX Composite ETF at a very low cost. You can buy it, and leave it, and never look at it again kind of thing, but there's a lot of people out there that have been traditionally investing into different areas of the investment landscape, coming up with new themes, coming up with different ideas, taking traditional asset classes and strategies that investors have always had interest in, but have not had easy liquid access to, and building an ETF around that.
Steve Hawkins: It takes a lot for us to create an ETF idea. Like to your point about me-too products, when we launched the very first actively managed preferred share ETF, now there's 9 or 10 of them. There's always going to be those me-toos, and you're always going to have an obligation to understand who's doing that active management. But for us, it's a niche where we're always going to be trying to innovate, create new product. We can charge more fees generally for access to new and novel asset classes for new and novel strategies. We're going to be able to continue to compete on that basis.
Clare O’Hara: Michael, your thoughts?
Michael Cooke: Well Mackenzie's been operating in Canada for over 50 years now. Among the attributes that make for a successful ETF issuer, investment management, brand equity, and access to distribution, you really, ideally need all of those elements to succeed that's why it's become so prohibitive for new entrance, new asset managers to get into this space why we're seeing now banks, large established independent asset managers see some runway with ETF strategies.
Michael Cooke: We've lived harmoniously with our colleagues in banking for years, for decades. They got into the mutual fund game relatively late compared to a number of the independents and they have their rightful place in the industry now. I think if you've got a good value proposition, you have a demonstrated track record of delivering value add for your clients, you bring relevance to your clients, there's place for a number of credible, independent and bank-owned asset managers to succeed in this space, but you just need to demonstrate to your clients that you're committed, that you have a credible strategy. There's a number of side show issuers out there now that are trying to latch onto the headline growth and hype about the ETF industry. You're going to be exposed if you're not committed to delivering relevance to your client, so it's something we're mindful of and I know my co-panelists feel the same way. You got to have a credible strategy, you got to bring relevance, and if you do, there's going to be a place for you alongside the banks or any other independent.
Steve Hawkins: We've seen most of the flows from ETFs still go to the top 5, top 10 issuers. The top 5 ETF issuers control 90% of market share, top 10 is 96% of market share.
Steve Hawkins: To Michael's point there's a lot of new up and comers, it's going to be very difficult for them to get to scale, but there's still 3,000 plus mutual funds out there and those are still existing. There's more than 350 mutual fund providers out there as well, and we haven't seen a lot of shrinkage in that marketplace, so there's going to continue to be those fliers that are trying to take advantage of the ETF marketplace and build some wealth for themselves, but being a long time established ETF provider like Mackenzie, we have cemented ourselves into this marketplace. We're the fourth largest ETF provider in Canada with over $10 billion of assets under management. We're here, we're established, people brand recognize us and it's going to be very difficult for people to, new entrants, to come into the marketplace and create a brand for themselves.
Clare O’Hara: Andres, from a research and analyst point of view, do you think the banks will dominate like they have in the mutual fund industry? Do you think they'll have the potential to boost, we're talking about the top four, will they all be banks at one time?
Andres Rincon: I don't necessarily think so, no. You're going to have the [inaudible 00:42:31] and Horizons and Mackenzies of this world will always be there with innovative product that the bank might not be able to provide or the banks might not have expertise in. I don't think necessarily that will be the case. You're always going to have the small providers that's going to come in with something that's innovative. They're going to have a great sales force, and they're going to sell some product. Then there's going to be also some consolidation in the industry, sure you're going to get some of the smaller providers maybe consolidating to became a top 10 and then you go from there and there. I think not all the banks will put their full weight into the ETF market just yet, at least not in the next couple years, so if I like 4, or 5, 10 years, I don't think it's going to be all the banks that are going to be up there. Obviously, there's going to be some, but not all of them.
Steve Hawkins: When is TD going to really put their shoulder behind the ETF [crosstalk 00:43:24].
Andres Rincon: I wouldn't know.
Michael Cooke: But every asset manager, whether they're bank-owned or not, has their own priorities, their own core competencies, which may or may not include an expansive ETF strategy. Every bank is unique in its own way how it approaches asset management, so we'll see what the future brings. It's not for the faint of heart, it's not an easy industry to compete in, despite the impressive headline growth. Like I said, you want to have a committed strategy if you're going to excel in this space. If you've got other priorities maybe an ETF strategy is not at the top of the list for you, but I think we'll see in time.
Clare O’Hara: You're absolutely right, because I think I could say from every provider out there, and every bank and every firm has said to me at some point, "We're never going to get into ETFs," 10 years later-
Steve Hawkins: Here they are.
Clare O’Hara: .... they're all in the space. Just on that Michael, when you entered the ETF space, because Mackenzie was one of them that probably said that to me, how did you decide to come in and differentiate yourself because you weren't one of the first ones to come into this industry?
Michael Cooke: Yeah, you're right, although, it feels like we were an early mover now that there's 36 odd providers-
Clare O’Hara: That's true.
Michael Cooke: . because we were 11th. But you're right, we were not a first mover, but we looked at where our strengths were, certainly, like I said, brand, our investment management history in Canada. We noticed a particular gap in active fixed income where we have among, I think, the best fixed income teams in the marketplace, not just in Canada but globally, and we saw a gap that was filled there. We responded to our clients about what their needs were and we led with some of our best in breed active strategies delivered in ETF form. Now, they were differentiated by the construct of ETF operationally and otherwise to fit in nicely with the ETF wrapper, the ETF packaging, but we were repurposing some of our best in breed strategies. Going along, I always knew this before joining Mackenszie, it's 50 plus year legacy, a rich tradition of excellence and asset management in Canada. The other competitive advantage is a homegrown, Canadian owned business, broad based distribution, strong brand, that we had a lot of the elements required to succeed as an ETF issuer, not just in the niche section of the market, but much more expansively. It's still a long journey, a long road, and the competitive pressures are intensifying every day, but we do think we have a compelling value proposition that's going to help us succeed in this industry.
Clare O’Hara: Moving on to thematic ETFs, last year cannabis, Bitcoin, block-chain, those were all the big stories last year, but where do you feel the next theme is? Steve, I'll start with you because I'm just staring at you about the whole cannabis. We don't have to get into the cannabis conversation, but where do you think-
Steve Hawkins: Let's talk about cannabis.
Clare O’Hara: Where is the next big HMMJ, which is your pot ETF, but what's the next theme?
Steve Hawkins: I think there's going to be continued growth. We look at the cannabis industry very much like the ETF industry. We're still very young. We're still in the early stages of this industry from a growth perspective and we're going to mature, both from a cannabis industry perspective in Canada, especially since we have the first mover advantage, but the ETF advantage industry is jumping alongside very quickly to that. We see so many different types of ETFs in the U.S., we're seeing a lot of those strategies come to Canada either through U.S. providers coming here, or established asset management companies coming up with their own ETFs.
Steve Hawkins: For us specifically, we see technology really, and socially responsible investing is really the two keys for 2019. We've seen a lot of new product already come out in the asset allocation play, and things like that. But when you're looking at thematics, specifically, new technologies the way that people are living their lives now. It's becoming more and more automated all the time, AI, robotics are being used in pretty much every aspect of our life, as well as cell phones and things like that. Those are all new technologies, they're all evolving from that perspective, so we see significant growth prospects there.
Steve Hawkins: But nowadays, investors are really starting to put their money where their mouth is when it comes to socially responsible investing. People understand the environment is not going to stay the same way it is for our children or our grandchildren down the road, and we need to be more conscious about how we're living and where we're investing our dollars to promote probably a better world for all of us to live in or our children or grandchildren to live in going down in the future.
Clare O’Hara: Are you seeing that Michael too around social responsible investing and themes at your firm?
Michael Cooke: Yeah, absolutely. I think it's still early says in terms of retail at option. But certainly, if we look at the next 5, 10 years or so, there's going to be a growing preference for customized investment strategies that allow an investor to express a particular view of that social responsibility or good governance, or other important considerations. We just want to make sure like any asset manager, any business owner, we're bringing relevance to the marketplace and making good decisions.
Michael Cooke: There's still lots of room for innovation in the Canadian ETF market. We launched what we think is a somewhat unique strategy in Canada last year that offers direct exposure to the Chinese market, in the e-shares market. There are other products out there that might give you indirect exposure through ADRs or U.S. listed Chinese companies, but if you want a pure play on the economic miracle unfolding in China and companies that are participating in that we think we've got a unique solution in that regard. There's many different ways to deliver innovation in the marketplace, but again, you want to make sure that you're bringing relevance, that you're not providing solutions to problems that don't exist.
Michael Cooke: The market is moving so quickly, as you know Claire, and you want to be responsive to changing investor sentiment, whether it's a growing appetite for SRI, or pockets of capital markets that are still not really touched by the ETF. If you can put a thoughtful strategy in the ETF form that's cost effective, that's liquid, and that has a strategy for scale there's lots of room to innovate in many segments, many themes in the ETF market.
Clare O’Hara: Andres, are you seeing any themes out there whether maybe they're in the U.S., and they haven't come over yet, but is there a gap anywhere that we don't have here in Canada?
Andres Rincon: I'm not sure if it's gap ... Well directly with regards to that question, customization has become a big thing in the U.S. where you have a lot of companies offering the ability to get into an ETF portfolio and it's fully customizable. Many of these will involve ESG strategies already, but they might involve a variety of different strategies really. I think that's maybe the future where we can start seeing that in Canada.
Andres Rincon: But back to the point that you were referring to originally, ESG strategies are all SRI strategies too. They've been growing quite substantially in the US. What's interesting is we just came back from Inside ETFs down in the U.S. and every other panel was an ESG strategies, so it's something that over the last few years we haven't really seen. Obviously, there's been a lot of talk about the growth of these strategies. AUM's growth has been moderate I would stay. But when it comes to interest in them, they've grown quite substantially.
Andres Rincon: When it comes back to the cannabis conversation, one thing that's interesting in the work we've seen is maybe what we'll see is the evolution of the index in how it will change over time. For example, we had making an investment in , basically an alliance with one store, and that's just a little piece, but as different players come into the cannabis industry you're going to get different companies going into that index that will change the face of what a marijuana ETF looks like.
Clare O’Hara: Just following on the thematic ETF issue here, liquid alts is a big topic that's coming out. We're seeing product being launched, the regulators have made changes. I just want to get thoughts from everyone on is that going to be a theme this year and are we going to see more providers step into that space?
Steve Hawkins: As the first ETF provider in Canada who's come to marketplace with liquid alts, we've been in this marketplace already for 10 plus years providing liquid alt ETF solutions for investors out there. The rules have changed and you can put more into an 81-102 structure now of an ETF. But, we have our traditional commodity pools that have been around for 10 years. These are all liquid alternative strategies and under our new perspectives filings we're required to shift those now into 81-102 structures, but we call them alternative ETFs, kind of things. It's just a new branding of an old way of doing ETFs.
Steve Hawkins: We really don't think it's going to change the market too much. We have already been out there from an access perspective. We've been out there educating the marketplace and investment advisors on liquid alts, liquid alternative strategies and market neutral strategies. These all exist right now. They've been in place for a while. What you're really going to see though is you're going to see more providers come in with their traditional offering memorandum strategies where they haven't had a lot of retail access to those marketplaces. It's a very, very closed network from a distribution perspective to sell those liquid alternative offering memorandum type products.
Steve Hawkins: With the rule changes in 81-102, it does allow them more flexibility to be able to bring those products and create a strategy around the way that they've managed that money traditionally and put it into an ETF wrapper. It could be a mutual fund wrapper, it could be an ETF wrapper, from a regulatory perspective it doesn't really matter. But for us, we've been in this marketplace for a long time. We really don't see a lot of changes. The one really nice thing that I think will come out of this though is because there will be more product in the marketplace, there's not going to be a proliferation, but there will be more product out there, there will be more people educating investors, whether they be retail, self-directed, mom and pop. There will be more people out there educating them on the products themselves, the strategies themselves, and I think that's going to bring more awareness to ETFs and mutual funds that are running alternative strategies.
Clare O’Hara: Great. Michael, so at Mackenzie I know you don't have an ETF product that's in that space, but you have already been in the liquid alts on the mutual fund side, what's the conversation like now at Mackenzie?
Michael Cooke: Well, it's a great innovation for the industry and it's bringing institutional investment technology to the retail advisor, retail investor and I think that's always a good thing to help craft better outcomes for investors. The question that I'm trying to answer is certain strategies lend well to the ETF structure and certain don't. We've already seen it with some of the products that are in the marketplace where they just don't make a good fit with the ETF structure, they're not liquid enough, maybe they're overly expensive or overly complicated.
Michael Cooke: From a manufacturing standpoint, it's trying to strike that appropriate blend between something innovative, value added differentiated, but not too expensive, not too complicated. I think that's where asset managers are really going to have to put some thought against whether some of these strategies are best accessed in a more conventional mutual fund forum, as opposed to an ETF forum. I think more education too, because I think there's still a little bit of confusion about what liquid alts exactly are. Steve touched on it, but you've got liquid alternative asset classes and alternative investment strategies that are being lumped under the same banner. Like to Steve's point, liquid alts have been around in different forms for a long time. Commodities as an asset class would be viewed as alternative, they've been available under the ETF wrapper for more than a decade now. I think the nuances need to be better understood, alternative strategies, long-short strategies, leverage strategies, arbitrage strategies, that would be better defined under liquid.
Michael Cooke: Alternative investment strategies I think are the new frontier, but it's just trying to find that blend between something innovative and whether it's best delivered in ETF form. I'm sure we and others will figure that out in time, but you just want to be mindful of all of those elements because it's not just as simple as throwing something out there if it's not competitively priced, if it's too complicated, if it's too expensive. You got to be winning all of those factors into new strategies.
Steve Hawkins: I'll give you an example, we launched a long oil short natural gas ETF. It's a very strong institutional strategy, it's been out there a very, very long time, very educated institutional investors have been using futures for a very long time to do these types of strategies. It was the best performing ETF in Canada that year that we had launched it. We kept it alive for two years, we thought we could garner some assets, we thought we could educate people on these institutional strategies, we closed the ETF. It was priced well, it performed fantastically, it did exactly everything it was supposed to be doing, but the investing public out there in ETFs really didn't understand that complicated of a strategy in an ETF. They were still thinking about TS 660, and S&P 500 and gold as just traditional ETFs.
Clare O’Hara: Has that changed though for the retail investor to still understand some of these liquid alt strategies?
Steve Hawkins: Absolutely. But again, to my point, I think that's where the education's come in, that's with this changing marketplace and more people out there actually educating the strategies. As Michael said, there are so many different types of strategies you can fit under liquid alternatives from a discussion perspective. But, the more people that are talking about it ... When we first launched actively managed ETFs the very first three actively managed ETFs that we launched people had absolutely no idea that you could put active management in an ETF. We ended up closing all three of those actively managed ETFs, and that's just the way the marketplace was. There wasn't enough people talking about it, there wasn't any education out there. People just said, "No frigging way can you do active management in an ETF," and here we are today now with 50% of the ETFs that are being launched in Canada are active management in some way, shape, or form.
Clare O’Hara: Andres, just on the liquid alt side, what are you hearing, are advisers coming, do they have questions, are they reading about this and wanting to find out more?
Andres Rincon: Yeah, slowly we're getting more and more questions on that side. For the ETF space it's obviously relatively new, but many of these products have been out there for a long, long time, so we're getting more and more questions about it as they become popular in the ETF space.
Andres Rincon: From a market making point of view, it's great that these products now can be housed within the ETF framework, but I would agree with Michael that really depends on the complexity of the strategy. All the traditional long-short strategies are great within ETF, so if you get really far down the rabbit hole in terms of the complexity of the strategy it might be a bit hard to execute via an ETF because at the end of the day, market maker has to price those strategies on a daily basis to be able to value the ETF fairly every day. Generally speaking, the traditional long-short there's some leverage here and there and borrowing should be pretty simple strategies for investors to understand and for us to make markets on.
Clare O’Hara: Well I want to thank everyone for your participation today as we wrap up. But maybe you can all leave us with a final thought on what you want advisers to think about, whether they're new to investing in ETFs or they're just thinking about it. How can they do that and what's maybe significant about the ETF product?
Steve Hawkins: Well, let's start by saying sell all your mutual funds, buy ETFs, it's a very, very important point. Advisors generally are really getting more involved in managing the money for their clients. As I mentioned, I believe Alpha's switching now from single stock picking to more of an asset allocation play. ETFs really can provide easy liquid access in a very cost efficient manner, in a very execution efficient manner, and very, very quickly done to an asset class. You'll be able to change your books very, very quickly. The way you manage your business is very, very important.
Steve Hawkins: Not all investment advisors want to manage all the single lines of preferred shares anymore. You can look at a professional asset management company who does that for us, and they will manage that book for you in a nice, cost efficient product with all your lines in there already, and will do it for a nice, cheap fee. But it's going to give you more time to manage your clients, it's going to give you more time to prospect for your clients. ETFs, cost-efficient, liquid, simple, very transparent. Even our non-transparent active ETFs are transparent, for all intents and purposes, we do publish the holdings.
Steve Hawkins: The investment advisors have been traditionally using mutual funds. Mutual funds have always been non-transparent in that regard, so there's no real difference between an active ETF and a passive ETF from a transparency perspective where they're used by investment advisors.
Steve Hawkins: I guess my ending point is really we need to understand what investment advisors want and we are trying to bring those products and strategies to marketplace for them to help them manage their business more efficiently. ETFs right now are the most efficient way to do that and we're going to continue to bring and develop new product for them to be able to use so that they can manage their business better.
Clare O’Hara: Andres?
Andres Rincon: Well as a TD, as a market maker of ETFs the message that we really want to get across is that we are here to support the industry, we're here to support ETFs from all of our partners because we do make a large chunk of the market. Our goal here is to make sure that you're investing and his investor wants to trade an ETF that we're there to support them and have the tightest spread possible. That's the message that I want to get across is that be at Mackenzie, be at Horizons, be at whoever it is, they have many of the market makers as partners to make sure that we make the best spread for those ETFs. This is for the institutional client, this is for the retail adviser, and this is for mom and pop.
Clare O’Hara: Do you interact like an advisor can call you directly if they're having trouble on the trading side of things?
Andres Rincon: When I was a TD advisor, for example, we'll call our retail desk that will execute that trade via our ETF market making desk.
Clare O’Hara: Great. Michael, what final thoughts?
Michael Cooke: I'd say that any healthy, vibrant industry tends to be characterized by competitiveness and by choice. We've talked a lot about the proliferation of new products that have come to market, the number of issuers, there's a lot of good stuff out there and it can be daunting on the one hand to have to navigate through that. It requires more homework, more due diligence, but financial advisors, investors, are facing increasing challenges to achieve their outcomes today, so I think having more choice is a good thing.
Michael Cooke: If you're a relatively new issuer like Mackenzie, give us a chance. I think we've assembled one of the best ETF teams in Canada, a lot of dedicated professionals with varied backgrounds that are singularly focused on delivering a good ETF experience to our clients. We think we've got a compelling value proposition. We're not the first mover, but we think we can be a highly relevant player in this space. I say that amongst many of our peers and competitors that have a good story to tell, they have good talent working in their firm, so they may not be a household name yet in the ETF market, but they're quickly on their way to becoming one. If you can demonstrate that you ] relevant, and thoughtful and mindful of the needs of your client, there's room for this industry to grow with more top tier issuers and more products. I'd say just have an open mind and look at the needs of your business as an advisor or your needs as an investor and do a little more homework. You're going to find the choices at your disposal now are really, really compelling in the Canadian ETF industry.
Clare O’Hara: Great. Well thank you to you all. I'm Clare O’Hara with The Globe and Mail and this has been Asset TV's ETFs Masterclass.