ETF sponsors are under pressure to cut MERs to the bare bones. That’s generally a good thing. But some wonder if that will force an ETF provider out of business.

It’s certainly a valid question. Some years ago, both TD Asset Management and State Street Global Advisors exited the Canadian ETF business, then an $11 billion industry.

In some sense, it’s a matter of steak and sizzle. TDAM and SSgA were competing with Barclays Global Investors on the price of steak. But there’s not much sizzle if all you’re doing is tracking a broad index. Indeed, as the Canadian ETF Association (CEFTA) notes in its first-quarter commentary: “at the end of February 2014 actively managed Canadian equity multi-cap funds recorded a one-year asset-weighted average return of 17.3% compared to 10.8% for the S&P/TSX Composite Index. Additionally, double-digit equity market returns have likely alleviated the cost concerns for advisors and investors.”

Sizzle won out over the steak. But that’s not the whole story. CEFTA mentions the emergence of “smart beta” strategies. That fits in with a theme articulated recently by Vanguard’s Dean Allen who, in a TSX presentation, noted that advisors focus not so much on asset allocation between stocks and bonds, but sub-allocation – the sectors or countries that will outperform.

This is where ETFs will come into their own. Retail investors generally seek broad market exposure to complement their stock-picking—basically “core and explore.”

Advisors do the same: cover the basic ingredients and then add a little spice. ETFs make that easier. For example, the variety of dividend ETFs on offer, in Canada and the U.S., reduces the need to be a stock-picker. The ETFs are already doing the work – screening dividend payers on the basis of yield, payout ratios and buyback/dividend-increase history.

Of course these are not, strictly speaking, passive investment strategies. They are rules-based and, as such, have an active component. But this is where ETFs will thrive: by providing steak with sizzle.

Scot Blythe is a Toronto-based financial writer.
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