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Canadian ETF demand moves into orbit

Low fees, regulation and popular demand are pushing Canadian ETF demand into stratosphere in first half of 2017

For the five months ending May 31, net sales/flow of ETFs reached $12.2 billion, which translates into an annualized pace of almost $30 billion, according to figures from Credo Consulting.

That’s nearly double the rate from 2015 and 2016, when ETF demand stood at identical record levels of $16.4 billion, and up significantly from an initial demand record of $11.9 billion in 2012.

The figures are especially impressive when you consider that for the two years following 2012, demand averaged $7.6 billion – and that despite the rebound in 2015, the following year was steady. The failure to build on those initial records seemed to at one point indicate that ETF demand was destined to keep struggling to really take-off.

Discussions of ETF demand are best put into context by comparisons to mutual fund demand, since those are the vehicles ETFs seek to displace.

With four months of mutual fund demand data available for 2017, the seasonally adjusted annualized pace of net sales stands at some $41 billion – well above the trend for ETF demand ($30 billion, as mentioned above).

It is worth noting, however, that mutual fund assets are about 11 times the size of ETF assets.

As well, ETFs still have a very minor component of “fund of funds,” whereas the domestic mutual fund industry is heavily and increasingly reliant on them. This distinction tends to indicate the two sets of investors are far from homogenous.

When it comes to structural differences between mutual funds and ETFs, however, it’s also becoming increasingly difficult to argue ETF demand is growing because of the relative advantages of ETFs over mutual funds. While ETFs’ lower management fees were a key driver at one point, that idea is no longer new.

One contributing factor may be new disclosure rules meant to allow mutual fund holders to clearly understand the fees they pay, but we do not see absolute mutual fund demand held back by the success of ETFs.

The intense marketing of ETFs, along with virtually unanimous support from the domestic financial media, must also be a positive contributor to rising demand – as well as the near-complete silence from the mutual fund industry, which seems unwilling or unable to speak up in its own defence. In fact, during the past year, most of the new ETF industry entrants have been traditional and well-established mutual fund providers, in what appears to be a “if you can’t beat them, join them” approach.

So, where is all this ETF demand going?

On a rolling 12-month basis through May, total equity ETF net flow stands at $9.97 billion, while total fixed income ETF demand stands at $9.36 billion (out of a total of $20.31 billion, as compared to $17.84 billion as of May 2016).

During the past year, fixed income ETF demand actually increased by $4.16 billion, while equity ETF demand declined by $2 billion.
Depending on one’s view of bond prices – as well as on to what extent investors really do tend to head for the hills when bond markets weaken – there may in fact be a bit of froth on the ETF demand front.

With global equity markets currently around record highs (and various volatility measures at decade lows), equity ETF demand may be considered somewhat frothy as well, if there’s more downside than upside for equity prices in general over the next several months.

One of the more ubiquitous marketing buzzwords in the domestic ETF realm right now has to be “Smart Beta,” or more elegantly put, “Strategic Beta.” This is a type of rules-based approach to asset selection (primarily within equity ETFs) that may reduce risk and squeeze extra returns out of any asset mix.

This group currently represents about 13.8 per cent of ETF assets, and during 2016, accounted for about 24 per cent of total net flows. However, in 2017 strategic beta demand has so far hit a wall, as year-to-date net flows are some 66 per cent below year-ago levels.

Analytically, it is possible to systematically pick away at recent ETF demand in order to show things are not as robust as they appear. There is some double-counting within the fixed income categories as fund of funds invest in other fixed income ETFs, for instance, while the slew of new entrants in recent months have given demand a one-time boost.

But no matter how you look at it, the domestic ETF space has catapulted into a new demand range. Its levels will likely oscillate somewhat as underlying financial market conditions fluctuate, but ultimately the frontier has been significantly extended in 2017.

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