Demand for Exchange Traded Funds has exploded during the 21st century thanks to steady returns and ultra-low fees. But it is difficult to determine just how much the traditional mutual fund business has suffered. Conflicting data points and a variety of newer indices haven’t helped in the ETF vs. Mutual Fund debate.
ETF Explosion
ETF demand has skyrocketed as investors buy into the marketing pitch that these instruments can match equity and fixed income index returns via lower fees than comparable mutual funds and zero embedded/trailer fees to advancers.
The ETF indexation proposition that active managers cannot beat market indices over time and that implicitly most mutual funds are an inefficient mode of investment has seen Canadian ETF assets under management soar. They’ve ran up from $12 billion at mid-2005 to $85.5 billion at mid-2015 and with reasonable prospects of hitting $100 billion by the end of 2016.
However, it is not clear to what degree ETFs have been taking away demand for more traditional mutual fund products or creating demand that might otherwise not have been there. Conflicting pieces of data and a variety of newer ETF indices haven’t helped.
Shifting Data, Indices
Are Canadian ETFs and mutual funds really in a battle for the same investor dollars? The answer is yes and no.
At present, the mutual fund industry is apparently not at all engaged in the media dialogue over the merits of ETFs versus mutual funds. That may lend an air of dignity to the market share battle but appears to be a concession towards the inevitable inroads being made by the ETF segment of the investment funds industry.
What the mutual fund industry has done is implement certain optics which serve to downplay the absolute share of ETFs in the investment fund sphere. For example, in 2011 the Investment Funds Institute of Canada (IFIC), began to define the size of the domestic mutual fund industry as the traditional base of its long standing reporting members along with those firms not reporting to IFIC (the non-IFIC data is compiled by third party sources). Accordingly, as of the end of 2014, the size of the mutual fund industry in Canada stood at $1.18 trillion with a split of $924 billion for IFIC reporting members and $255 billion for non-IFIC members. Hence, under one scenario, the ETF share of the measured investment funds industry stood at 7.7 per cent at the end of 2014 versus 6.1 per cent under the broader measure.
At the same time, the ETF industry does not fully trust its own value proposition as over time an increasing share of ETF assets and net sales have been of the non-broad market index or active variety. For example, the first ETFs followed broad market indices such as the TSX 60 or the Canadian Universe Bond Index and represented about 76.2 per cent of assets at the end of 2005 but as of mid-2015 represent just 38.7 per cent of assets and year-to-date share of net flows of just 11.3 per cent. Alternatively, as of mid-2015, so called active ETFs (as designated by the Canadian ETF Association) represent about 11.5 per cent of total ETF assets and on a year-to-date basis represent about 27 per cent of industry net sales. The rest is an amalgam of a wide array of index ETFs and quite simply a lot of so called passive labelled ETFs which some observers calculate to represent about double the “official” market share of active ETFs suggested by the CETFA. While none of this is necessarily a problem the apparent inconsistencies in the ETF marketing message is non-trivial.
Another aspect of the ETF product line is the creation of funds with indexes that do not exist in mutual fund land. For example the Canadian Bond market has long been tracked by the FTSE TMX Canada Universe Bond Index™ (the name has changed several times) and the original ETF that tracked this index is and has been true to first principles. However, alternative universe bond indices have been introduced as benchmarks for ETFs which over time have been easier to beat; one comparison has the alternative bond benchmark returning about 10.7 per cent during 2012/13/14 versus some 11.2 per cent for the classic domestic universe index. To some, these differences are minute but in bond land they are relatively substantial.
There are some ETFs which have little in the way of counterparts in the mutual fund industry and therefore cannot clearly be said to be taking away assets from mutual funds. Laddered fixed income ETFs for instance have about $6 billion in assets while mutual funds have less than $1 billion and are an example of supply creates its own demand. Finally, it is impossible to calculate how much of new ETF demand represents shifts from mutual funds, how much represents demand taken from mutual funds on a head to head to head basis and how much is specific ETF demand that would not have materialized if ETFs did not exist.
Caveat Emptor
It does not really matter if ETFs exactly replicate their mutual fund counterparts or are vague substitutes, the marketing fodder is substantial and the ETF contingent at this stage is formidable. An investor’s duty now more than ever remains “buyer beware”.
