advisor-client

Editor’s note: On Jan. 23, 2018, a BCSC representative, speaking on behalf of CSA, told Advisor.ca that the CSA “is still in the process of implementing the ETF Facts requirements.” As such, “There is currently no update to provide regarding a post-implementation review.” 

If you haven’t yet offered ETF Facts to your clients, that’s OK. CSA amendments mandating the summary disclosures aren’t in effect until December 2018 (see “Timeline of ETF and mutual fund rule changes”). But, as providers release more of the documents over the next year, use the opportunity to review portfolios with clients.

ETF Facts, CSA’s followup to the Fund Facts disclosures mandated for mutual funds, are meant to be more investor-friendly than prospectuses. They are no more than four pages long, written in plain language, and can be used in tandem with Fund Facts.

“Fundamentally, you [now have] two documents that are similar in nature that allow better comparisons of the two products,” says Neil Gross, president of Component Strategies Consulting in Toronto, and former executive director of FAIR Canada. Further, while Fund Facts don’t include a section on trading, the fact sheets for ETFs do. This will start conversations about that key difference.

But the new documents shouldn’t be seen as replacing prospectuses, says Gross, as those are critical documents that offer more in-depth information. Instead, treat ETF Facts as additional learning aids you can send to clients prior to discussing prospective investments or portfolio changes.

Another benefit of ETF Facts: the summaries encourage investors to look beyond fees. The main draw of the “exploding” ETF industry continues to be its low comparative fees, says Wes Ashton, portfolio manager at Harbourfront Wealth Management in Vancouver. But the new ETF documents shift that focus to what funds invest in, their risk, and how they trade. The documents reference the MER on page one and leave the detailed breakdown of a fund’s fees to the end.

When you’re reviewing ETFs and considering portfolio adjustments with a client, the fact sheets will help them see the big picture clearly. Instead of focusing on fees and individual picks, you can look at suitability and overall investment strategy. Below, we pick apart an example ETF fact sheet for client conversations. Download sample ETF facts here (note that the document uses an example fund and figures rather than an actual fund and its figures).

Let’s look in detail at each section.

What does the ETF invest in?

To help clients, Ashton suggests discussing this section in the following order: 1. Go over the summary, making sure clients are familiar with the index being tracked and the basket of underlying securities. 2. If they’re interested, talk about the fund’s top 10 holdings. 3. In the event a client wants to know more about how a fund’s constituents and sector exposure fits into their strategy, “a review of the investment mix of a fund would be ideal,” he says. “However, in certain cases, this could be overwhelming.”

Missing piece: Disclose whether a fund uses active strategies or is strictly passive, says Gross, and explain how that impacts its investment strategy and price.

Distributions

For this section, explain what fund distributions are and whether, how and why they’re reinvested. This ties into the later section on taxes.

Missing piece: According to CSA’s investor test results from January 2015 , some investors may request more information about a fund’s annual average rate of return; on page two of the ETF Facts document, you’ll find the ETF’s annual compounded return for the past 10 years. Clients may also ask about total units issued and average price per unit. Further, you may have to explain the MER, which doesn’t include the total expense ratio, or trading costs.

How risky is it?

This section is key, says Ashton, noting the document uses standard deviation as a risk measurement to categorize volatility. “We’ve consistently approached portfolio management utilizing standard deviation as a risk measurement, and have always talked about risk-adjusted returns,” he says, adding this is often overlooked. So, if you haven’t discussed those measures with clients previously, you may need to define them.

To add further context for clients, discuss this section along with the following one, How has the ETF performed? (this is on on page two.) This example fund was down 22.9% one year and 7% another year, so a client may say she’s not comfortable with that level of volatility, says Ashton, adding: “That’s one way to tell if it’s suitable based on their risk tolerance.” But, explain why the fund was down and how it compared to other similar funds over the same period. He suggests asking clients: “‘Do you think the [top 10] companies will be around in five, 10 and 15 years, despite the ups and downs of markets?’ If clients understand the companies they’re investing in, [that] minimizes the likelihood of making poor emotional investment decisions.”

Missing piece: “Consider that the S&P/TSX 60 Index ETF, which consists of the 60 largest Canadian companies based on market capitalization, is a fairly straightforward example. There are other funds that carry different types of risk,” says Ashton. “Think of leveraged ETFs [and] currency ETFs. Each of those carry their own inherent risks that you’d need to define and disclose to ensure [they’re] suitable for a client and [that she’s] comfortable with the risk.” The CSA’s investor test results show an ETF Facts document for a leveraged fund would include additional warnings about its speculative nature.

And, remember that standard deviation is only one aspect of risk, says Gross: “CSA’s testing results suggest investors may glaze over additional information about risk ratings, but volatility is only one element of risk. In the case of the TSX, for example, you’re getting concentration risk as you’re buying [heavily] into resource companies and banks.”


Trading ETFs

During client discussions, highlight timing. ETFs are more volatile at the start and end of the day, as the document notes.

Missing piece: Along with discussing the mechanics of ETF trading, mention the fund’s liquidity—how easy it is to trade. Many companies are launching products these days, and some of those funds will be smaller, says Ashton. “For smaller or more obscure funds, there are only so many shares that trade on a daily basis, so there could be a liquidity issue or a pricing discrepancy that you’d need to educate clients about. But if you’re dealing with larger funds, like [those that track] the S&P/TSX 60 Index, there’s a higher volume of shares that trade daily and, thus, more liquidity and less [of a chance of] price discrepancies.”

Gross points out: “There’s a general reference to [this] in the context of bid-ask spreads. The question is whether the average investor needs more detail” on how liquidity affects them.

Who is this ETF for?

By this point, clients should know whether they want to invest in the fund based on its holdings, performance and risks. This section confirms the fund is a long-term investment that will follow broad market movements.

How much does it cost?

This section provides a detailed breakdown of the fund’s fees, as mentioned on page one. Use this section to confirm a client understands the costs and your compensation.

Missing piece: Note tracking error, says Gross, “to alert the investor to the fact that the performance of the ETF is not going to be exactly the same as the index that it’s tracking, [partially] because of the cost.”

What if I change my mind?

Both Ashton and Gross suggest advisors use ETF Facts before selling a fund, if possible, even though CSA doesn’t require that. CSA also suggests that a pre-sale discussion of an ETF fact sheet is best.

CSA requires the documents be delivered within two days after a sale. One reason for this is there may be times to get into or out of a fund more quickly in order to achieve best execution. As the document notes, you also have two days to cancel an ETF purchase.

The potential risk of delivering the document after a sale, says Gross, is that clients may suffer from confirmation bias, where they’re reluctant to question the investment decision. “It’s a bit of a mystery as to why the CSA have not required point-of-sale delivery [of ETF Facts. …] It’s critical to get the information to [clients] before they make a purchase decision, because the likelihood they’ll even read the document after is low,” he says.

Timeline of ETF and mutual fund rule changes

The Canadian Securities Administrators have been working on a multi-stage project focused on transparency and the implementation of point-of-sale disclosure for mutual funds and ETFs.

July 2011

CSA says all conventional mutual funds will be required to prepare Fund Facts for each class and series.

June 2014

Every investment dealer is required to deliver Fund Facts for all conventional mutual funds prior to purchase, “instead of the prospectus,” according to a December 2016 CSA notice.

December 2014

CSA requires pre-sale delivery of Funds Facts for conventional mutual funds, effective May 30, 2016.

July 2015

CSA proposes amendments requiring the use of summary disclosure documents called ETF Facts, and also proposes a delivery regime. Prospectuses would still be available.

March 2016

CSA finalizes rules that ETFs must produce and file the ETF Fact disclosures, but with staggered implementation. The rules say the documents must be offered online, and investment dealers are required to deliver ETF Facts documents to clients within two days of an ETF purchase. But, ETF managers have until November 12, 2018 to file ETF Facts for all classes and series, and the delivery requirement for dealers won’t be fully effective until December 10, 2018 .

2017 and beyond

CSA notes in a December 2016 release that it plans to “conduct a post-implementation review of the ETF Facts and will consider whether further investor testing is warranted.” CSA also develops and publishes final amendments to a new mutual fund risk classification methodology.

Katie Keir is Content Editor of Advisor's Edge. Email her at Katie.Keir@tc.tc.

Originally published in Advisor's Edge Report

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