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David Stephenson, director of ETF strategy for CIBC Asset Management.
What product trends have we noticed in 2019? To answer that question, it’s helpful to look at the big picture. A lot has been written lately on strong ETF flows relative to mutual funds, and that trend has continued so far in 2019. ETF flows were $20-billion in 2018, and we’ve seen about $11.5 billion in ETF flows year-to-date. Total industry assets are just over $180 billion in total and, interestingly, of the $11.5 billion in flows, roughly half has been into fixed income and half into equities.
In the equity space, there has been interest in factor ETFs such as low volatility, and U.S. equity exposure has seen inflows as well. Another interesting category that’s seen very strong growth is asset allocation or balanced ETFs, which remain popular with investors. Some other interesting product trends have been in the thematic areas like infrastructure and ESG, which I expect will continue to grow in the next three to five years.
On the fixed-income side, passive Canadian aggregate bond exposure has seen very strong inflows while active fixed income remains popular with investors as well. Fixed income now has over $60 billion in AUM and is about one-third of the total ETF market.
What do we expect to see in the fixed income ETF space for the rest of the year? I expect the fixed income category will continue to grow. People talk about the growth of ETFs in general, which has been about 25% compound over the last 10 years, but fixed income is growing even faster. The core beta exposures on the equity side are placed in the six-to-eight basis point range for Canadian and U.S. equity, but there are significant opportunities in fixed income with the opportunity to outperform as well.
Active fixed income is now about 25% of the fixed income market in AUM, and I expect that to go further in the years ahead. Investors are looking for outcome-oriented products as well in fixed income to help them navigate markets, whether they are concerned about equity market valuations, low yield, interest rate increases, or just outsourcing to the ETF manager where to find the best opportunities. Fixed income ETFs offer a different solution to meet these needs, and I think that will continue to grow in 2019 and beyond.
So, what are the advantages of active and passive strategies? First, let’s start with passive strategies. The key advantage of a passive strategy is low cost, diversification, and transparency. For example, in Canada, you can get broad exposure to the Canadian bond market for nine basis points. It’s a compelling value proposition and you can use it as a core position or you can use passive strategies to make an active call or express a view in your portfolio—for example, using Canadian long bonds or real return bonds.
The advantages of active strategies. Given the size and scope of the Canadian fixed income market, there are many levers for active management to add value. Some of the benefits of active management are: one, the ability to avoid pitfalls in the bond market and position accordingly. A good example would be using active credit research and leveraging your best ideas. An example could be investing in a fallen angel that has fallen into non investment-grade, yet still offers a compelling investment opportunity.
Secondly, active funds can help navigate an opaque bond market—for example, access to new issues. So, using your size and clout as an active manager to assess compelling new issues for unit holders, and also you can select other benchmark holdings. For example, if interest rates are higher in the U.S. relative to Canada or we’re finding compelling valuations, an active manager has the ability to purchase these bonds to enhance yields.
And I think the last reason to highlight for the advantage of active strategies is the ability to manage interest rate risk and position accordingly on the yield curve. So, for example, an active manager can adjust a portfolio duration to protect capital by keeping duration shorter than the broad benchmark in an increasing rate environment or higher in a decreasing rate environment to add value. The key is flexibility to add value in both rising and declining rate environments.