Soon after RBC Global Asset Management and Blackrock Canada announced their ETF alliance in January, CIBC and National Bank issued their first ETFs. It’s now official: all the big banks are in.
Over the past 50 years, two events fundamentally changed the investment management industry.
- When baby boomers entered the workforce in the late 1960s, a wave of pension contributions ensued.
- Winners: Independent investment counsellors who emerged to manage the new assets.
- Losers: Insurance companies that had managed 100% of pension assets have been losing market share ever since (although retaining recordkeeping).
- By 1990, 58 years after the first mutual fund was introduced in Canada, all the banks had entered the fund business, providing mass public access to capital markets.
- Winners: 1) The mutual fund industry. Assets exploded from $25 billion (December 1990) to $426 billion (December 2001). 2) The advisor networks to sell and support them.
- Losers: Canada Savings Bonds sales, GICs for RRSPs, and 9% front-end loads.
Will bank endorsement of ETFs be the third fundamental change?
In half the time it took banks to endorse mutual funds—28 years after the first ETF launched in Canada—all banks have affirmed ETFs by issuing their own. Investment professionals have recognized ETFs’ tax efficiency, transparency and low cost for years, but when banks catch the “bug,” the entire industry sneezes.
What it means for banks
Asset management and other non-interest income now account for 43% to 57% of total bank revenues, up from half these levels a half-century ago. CIBC and TD are at the lower end, while RBC and BMO are at the higher end. Fees are important to banks, and ETFs present special challenges.
- Low fees: The average asset-weighted MER for large-cap Canadian equity ETFs is 0.21%, one-tenth to one-third of fees for comparable mutual funds, depending on the series.
- Training: Branch employees need additional training and licences to recommend ETFs, which are costly.
- Passive: Popular ETFs are passively managed, differentiated only by cost. Pricing flexibility is limited.
- Number of ETFs: Choosing is already difficult for most investors and many advisors.
Every bank has its own suite of core mutual funds: domestic equity, domestic bond, U.S. and international equity, and balanced. But does it make sense to offer yet another ETF replicating the S&P/TSX 60 with a 0.06% MER?
Portfolios of ETFs
Unbundling investment products and services is inevitable. Global regulatory pressure for more transparency will eventually overtake the industry’s rear-guard attempts to retain embedded commissions and obscure principles like fiduciary responsibility.
It is ironic that banks have bundled ETFs into mutual funds as a solution to unbundling. BMO ETF Portfolios pioneered this path in 2013 with five actively managed mutual funds composed of 10 to 22 BMO ETFs. In early 2019, CI Investments launched five CI Mosaic ETF Portfolios that follow the same idea using primarily First Asset ETFs. Expect RBC/Blackrock and others to follow in short order.
Resulting mutual funds of ETFs offer simplified portfolio construction and, importantly for banks, require no relicensing or retraining for branch distribution. Costs can be lower. The five BMO ETF Portfolio F series funds with MERs ranging from 0.51% to 0.66% are on average 43 basis points lower than comparable F series mutual funds. The CI Mosaic ETF Portfolio F series MERs range from 0.67% to 0.78%.
Reduced product shelves
With ETF bundling, product shelves will narrow. Enhanced know-your-product regulations mean dealers want advisors to use fewer products to limit liability and possibly highlight in-house products. Boutique or niche product providers will struggle for shelf space. Industry consolidation is likely.
Client acquisition costs are high, so retention will be more valuable in the lower-margin ETF world. Technology-enabled, goals-based investing that matches investors’ needs with portfolios using ETFs will help. This solution will still be “sold” as a product through traditional distribution channels, but the current obsession with performance could be replaced with improving the probability of achieving goals—which could be “stickier” from a marketing perspective.
Advisors will spend much less time investing and more on fee-based financial, tax and estate planning, with the ability to bundle ancillary services. Will investment management fundamentally change? Yes.
Mark Yamada is President of PÜR Investing Inc., a software development firm. Disclosure: PÜR Investing Inc. provides risk-based model portfolios to Horizons ETFs.