Mutual Fund Demand Has Hit a Wall as Sales of ETFs Surge

The Canadian love affair with Exchange Traded Funds shows no sign of abating. In fact, demand for ETFs continues to head higher while sales for traditional mutual funds is dropping sharply.

Recent figures show that sales of Exchange Traded Funds (ETFs) in Canada are fast eclipsing demand for traditional mutual funds.

Canadians have been keen to embrace ETFs because they offer wide exposure to a variety of securities and are traded daily on stock markets. Because they track an index, management fees are much lower, typically well under one per cent. In contrast, an actively-managed Canadian equity mutual fund could easily have a management expense ratio of 2.5 per cent.

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Figures out from Credo Consulting show that assets of ETFs under management in the first quarter of 2016 got within reaching distance of the $100 billion threshold, coming in at $95.2 billion.

Net inflows of ETFs stood at $5.4 billion during the first quarter versus $4.6 billion a year earlier. At the same time, the Investment Funds Institute of Canada (IFIC) reported that mutual fund net new sales (close equivalent to ETF net inflows) sustained a stunning drop of well over 50 per cent, standing at $9.2 billion versus $22.2 billion in the same period a year earlier.

Based on our forecast methodology, and just focusing on long-term fund demand (excludes money market funds), we estimate ETF net flows will total about $14.7 billion in 2016 versus $16.2 billion in 2015. In contrast, after 2014 and 2015 net new sales of long term mutual funds of $49.9 and $49.6 billion respectively, 2016 appears on track for about $25.5 billion – a near 50 per cent annual decline. This is quite the relative demand outperformance for ETFs as mutual fund assets are about 10 times greater.

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While it’s generally correct to observe that ETFs are taking over, there is actually a huge part of mutual fund demand against which ETFs cannot be said to be competitors. Specifically, Balanced Funds represent a mere 1.4 per cent of ETF assets while the figure is 55 per cent for long term mutual funds.

For 2016, we estimate balanced fund net new sales will decline from $36.7 billion in 2015 to about $18.8 billion in 2016 and this negative swing of $19 billion represents the lion’s share of the $24.1 billion downswing in long term mutual fund demand during 2016. Put another way, long term mutual fund demand excluding balanced funds is projected at $6.7 billion in 2016 versus $12.9 billion in 2016. This means the competitive aggregates against which ETFs compete are still doing poorly in demand terms; semantics perhaps, but noteworthy.

For ETFs, demand is relatively concentrated. On a 12-month basis through March 2016, the top demand performer was U.S. Equity with net flow of $2.8 billion followed by International Equity at $2.4 billion and Canadian fixed Income at $2.3 billion. The total net flow of these categories of $7.5 billion represents 44 per cent of total ETF flows but only 33 per cent of assets.

In summary, ETF demand continues at robust levels and seems more unstoppable than that of mutual fund demand in general. As ETF assets grow, the case for their adoption becomes more self-fulfilling. The mutual fund industry appears to have no vocal answer to the growth of the ETF industry other than perhaps joining in: TD and Mackenzie Investments have recently launched ETF suites and another U.S. entity (WisdomTree ETFs) has announced plans to begin offering ETFs shortly. Given all this, the Canadian investment fund industry is “unfolding as it should.”

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NOTE: Frank Hracs is the Principal of Canadian Mutual Fund Analyst and Chief Economist at Credo Consulting.

4 years ago