ETF endgame

Will ETFs continue to elude MFDA advisors?

Twenty-five years ago, when Steven Kelman, president of an industry training firm, presented to insurance salespeople, he told them clients were going to start buying mutual funds whether they sold them or not. The industry responded by offering segregated funds: mutual funds in an insurance policy wrapper.

Canada’s mutual-fund industry is at a similar crossroads with ETFs, which remain out of bounds for mutual fund dealers because they trade on a public stock exchange. Some fund companies—like their insurance counterparts—have devised mutual fund wrappers to sell ETFs, but barriers to full-fledged access remain.

Good news; bad news

There’s good and bad news for MFDA advisors, says Davee Gunn, president and CEO of Hahn Investment Stewards.

ETF advantage

Canada has been criticized for having the highest mutual fund fees anywhere in the world. The SPIVA (Standard & Poor’s Indices Versus Active) research confirms the vast majority of mutual funds don’t outperform the index due to considerable fee drag.

Canada has been criticized for having the highest mutual fund fees anywhere in the world. The SPIVA (Standard & Poor’s Indices Versus Active) research confirms the vast majority of mutual funds don’t outperform the index due to considerable fee drag.

According to Dave Gunn, president and CEO of Hahn Investment Stewards, “If mutual funds aren’t going to outperform the index, why not just buy the index? The cheapest way to do that is through an ETF or a very low-cost index mutual fund.”

The real issue, Gunn says, goes back to the basic tenets of investing. “While fees and taxes are important, it’s really about asset allocation and the decisions advisors make for their clients. In that respect, ETFs are a beautiful vehicle.”

The good news: MFDA advisors can recommend ETFs. “ETFs are subject to the provisions of NI 81-102 (mutual funds), and MFDA planners can advise their clients on the purchase and sale of ETFs.” The bad news is there’s no operational infrastructure for MFDA advisors to execute those trades. “It’s like having a driver’s licence, but no car to drive.”

Sandra Kegie, executive director of the Federation of Mutual Fund Dealers, says both the MFDA and OSC have no objections to MFDA advisors selling ETFs.

“It’s more a market-access issue than a regulatory one. MFDA advisors need to, using existing market participants, find someone prepared to facilitate the exchange. Currently no one has stepped up,” she says. “We’re still in discussions with ETF providers to explore a structure where mutual-fund advisors can be provided access to an exchange.”

Yet Prema Thiele, partner, Borden Ladner Gervais, doesn’t see MFDA members making trades on an exchange in the near future, because there are significant proficiency differences between MFDA and IIROC reps that still haven’t been addressed.

Smart solutions

Unless MFDA firms invest in the infrastructure needed to trade listed securities, Gunn says the alternative might lie in mutual fund advisors routing orders through IIROC firms that provide correspondent brokerage services. “This way, the mutual fund advisor maintains the client relationship and would be responsible for KYC and KYP requirements.”

Dave Velanoff, senior consultant at Desjardins Financial Security Investments Inc., has taken this approach thanks to bundled prospectus arrangements with JovFunds. “Our advisors are allowed to sell mutual funds made up 100% of ETFs,” he says. “They’re also allowed to refer [clients] to separately managed accounts—in our case Hahn Investment Stewards—and receive a referral fee.”

Gunn says more MFDA advisors are referring clients to licensed portfolio managers to oversee the investment decisions while retaining primary responsibility of the accounts. “The best of both worlds [is] where MFDA advisors do what they do well [financial planning and relationship management] and outsource investment management to experienced portfolio managers.”

Such arrangements, however, work best for fee-based advisors. “Advisors still charging deferred sales charges won’t be happy with the rise of ETFs and their impact on commission-based income,” Gunn says.

Legally speaking

While ETFs are funds by definition, they’re bought and sold through a public exchange.

“Calling it a market access or operational issue might be a bit simplistic,” Thiele says. “The only legally acceptable structure is to refer a client requesting ETFs to an IIROC advisor.”

The problem with such arrangements, Thiele says, lies in the client assessment process. MFDA advisors believe if they’ve already done a thorough KYC, their IIROC colleagues don’t need to. Yet IIROC advisors have to fulfill their own KYC obligations. In addition, the MFDA advisor needs to fully disclose to the client any referral fees—clearly spelled out as a number or a formula for calculation.

Gearing up

Work needs to be done before MFDA advisors make a direct go for the ETF market. “The MFDA will have to ensure policies and procedures are clear,” Gunn says.

Kelman says it shouldn’t be difficult to bring MFDA advisors up to par, or to add a course to an existing MFDA training regimen. “All MFDA reps need is a light course to get acquainted with ETFs: how they perform relative to the index; the types; how they can be used; suitability; risk tolerance; how they’re issued, traded, redeemed and distributed; differences and similarities to mutual funds; and taxation issues.”

“A reasonably confident mutual fund salesperson would be brought up to speed in a couple of days of intensive training,” Kelman adds. Velanoff, meanwhile, predicts a merger between IIROC and MFDA within five years. “IIROC will become the SRO; the MFDA will fold into it. I don’t foresee IIROC pushing MFDA advisors to take the Canadian Securities Course to sell ETFs. The regulator might create separate categories of proficiency.”

When the two SROs do eventually talk, Kegie hopes MFDA members will remember why they value their current registration. “Whatever keeps them in this channel, they need to fight to keep it when it’s time for negotiations.”

MFDA advisors don’t crave ETFsM

The fledgling ETF market is fast maturing as more and more Canadians become acquainted with its considerable merits. And with bigger investors demanding ETFs, more than a few MFDA advisors have already crossed the street to become IIROC registered.

Despite the euphoria around ETFs, Dave Velanoff, senior consultant at Desjardins Financial Security Investments Inc., doesn’t think there’s panic among MFDA advisors. “In fact, a lot of money managers are rejecting ETFs because [using them] goes against their belief that they can outperform the index,” he says.

“People who get their securities licence after being MFDA-registeredsuddenly feel irked by having to sit in front of the computer all day and pick stocks rather than do financial planning,” Velanoff says. This group tends—for self-preservation —to stay with mutual funds and related products, and keep the stock picking for selective clients because they want to focus on financial planning.”

Sandra Kegie, executive director of the Federation of Mutual Fund Dealers, agrees. “I don’t think lack of access to ETFs is a big deal for MFDA advisors. If it had been a big deal, a lot more people would be trying to figure it out. Now that indirect access is available [through ETFs in a mutual fund wrapper] I’m not sure anyone is all that interested.”

Kegie is in discussions with several analysts, manufacturers and their legal counsel, investigating the possibility of white-labelling an ETF for Federation members. “Although the idea is intriguing, there just doesn’t seem to be a whole lot of interest in it.”

Kanupriya Vashisht is a Toronto based financial writer.