Where to expect ETF growth

Against the backdrop of the pandemic and the volatility that came with it, investor demand for ETFs is “stronger than ever,” says David Stephenson, director of ETF strategy and development at CIBC Asset Management.

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ETF flows surged in the first half of the year and were on track for their best year ever in Canada at the start of the fourth quarter, Stephenson said in a mid-October interview, noting that flows had exceeded $30 billion at that point.

“Barring a major reversal over the last two and a half months of 2020, this would eclipse the record of $28 billion set last year,” he said. “Even more impressive is that ETF flows remained positive in each month so far in 2020, despite some volatility in fixed income ETFs back in March.”

Both equity and fixed income funds have benefitted in the current environment, as investors have increasingly sought diversification when it comes to the asset classes and regions to which they’re exposed, he said.

Investors have also used ETFs to take advantage of the market environment, he said: “Gold and gold equity-related ETFs have seen strong interest for most of this year. There also continues to be a strong interest in active fixed income.”

Two other areas of interest are environmental, social and governance (ESG) ETFs and those that use derivatives.

“There’s been quite a few [ESG] products launched this year, as Covid-19 has awakened investors to the occurrence of a low-probability, high-impact risk which could include climate change — and [that] will also lead investors to look for companies with sustainable business practices,” Stephenson said.

Derivative ETFs, meanwhile, can increase yields and reduce volatility, or help investors “shape the pattern of returns over a defined period,” he said. For example, even while option writing ETFs aren’t new, products with a tail hedge are becoming more popular across North America.

While 70% of ETF assets are in products that track an index, Stephenson said he thinks active and specialized ETFs will start to pick up more assets.

“We’ve had active ETFs in Canada for over 12 years now and today they account for about 22% of industry assets, doubling in the last five years,” he said, adding that active products account for almost 40% of ETFs listed in Canada.

Stephenson said investors will probably continue to seek out funds that “respond to rapidly changing markets like we’ve seen in 2020,” and as more active ETFs are manufactured in the U.S.

Low fixed income yields are a hurdle for balanced funds, especially when it comes to Canadian government bonds, Stephenson said.

“Bonds are still an important component of a well-diversified portfolio, as they can hope to cushion equity volatility,” he said. “But the question looking ahead is what to do when 40% of your portfolio is yielding 1.3%, which is the current yield to maturity on the universe bond index.”

Despite “solid returns for bonds” on the back of yield declines in 2019 and 2020, Stephenson noted that “the best predictor of future bond returns is the starting yield. So, at 1.3%, it is clear [that] bond returns in the years ahead will be more difficult to achieve than in years’ past.”

Investors may turn to active fixed income managers who have the ability to invest across different regions and asset types, in areas such as U.S. high yield, emerging market debt and mortgage-backed securities, he said.

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