A rear-view look at a historic half-year for Canadian ETFs

From the world's first bitcoin ETF to the great rotation, Nirujan Kanagasingam of CI GAM reflects on what's defined 2021 so far

A rear-view look at a historic half-year for Canadian ETFs

Even amid a history-making pandemic crisis, Canada’s ETF space didn’t show any signs of slowing down last year. In fact, according to the Investment Funds Institute of Canada (IFIC), net sales of Canadian ETFs reached $41 billion for the full year, handily exceeding the $28 billion posted in 2019.

2021 is also shaping up to be another history-making year: with net sales through May amounting to $25 billion, and accelerating past $30 billion in June, Canadian ETFs are on pace to reach another record half-year period. But beyond the top-line dollar figures, the trends in flows into specific ETF categories provide insight into broader changes and shifts – some of which have been revolutionary.

“The Canadian ETF industry has always been a hotbed of innovation from both a regulatory and product standpoint,” said Nirujan Kanagasingam, vice president, ETF Strategy at CI Global Asset Management. “It’s also the reason why Canada was the birthplace of the first Bitcoin ETF in the world with a flurry of other crypto asset ETFs that have since launched.”

As Kanagasingam noted, the meteoric rise in the prices of crypto assets, coupled with the popularity of blockchain technology, have fanned demand among both institutional and retail investors. With the familiar hallmarks of efficiency and transparency they’ve come to expect from the ETF structure, access to crypto assets – including for registered accounts like TFSAs and RRSPs – has only gotten easier for DIY investors who might not yet be ready to dive into the technicalities of blockchain technology.

“While it’s hard to predict whether the current demand for crypto assets will be sustainable in the long run, one thing is certain: the legitimacy of crypto as an asset class is real and here to stay,” Kanagasingam said.

Another transformative trend, ESG, has been propelled forward by an acceleration in climate-friendly government agendas, notably through infrastructure policies encouraging a green transition, as well as changing demographic trends.

“The rise of ESG investing has also bolstered the appeal of clean energy investments, as more capital becomes allocated to fighting climate change,” Kanagasingam said. “We’re seeing Canadian ETF providers follow suit in order to meet this growing demand as the last few years have seen an increasing number of ESG products launched.”

As it stands, there are roughly 70 ESG ETFs listed in Canada today. Reflecting strong interest in sustainable investing, net inflows into ESG ETFs through May totalled $3.3 billion, 83% higher than the $1.8 billion that the category saw for the whole of 2020.

From a fixed-income perspective, inflation is emerging as a hot topic. While aggressive monetary stimulus has undoubtedly been instrumental in supporting financial markets throughout the pandemic, investors are now considering weighing the possibility that it has fuelled the economy to overheating, leading to an inflation reckoning.

“Investors are keeping an eye on Treasury yields as it steadily increased over the first few months of the year before retreating,” Kanagasingam said. “Within the fixed-income ETF space, investors are favouring bonds with shorter duration and less sensitivity to interest rates as $1.6 billion went into short-term bond funds through May.”

The uncertain environment has also dulled investor demand for passive fixed-income funds. Looking at bond funds ex money market, Nirujan said roughly 60% of net flows went to active bond funds YTD, reflecting investors’ desire for active management that can navigate through the short-term bumps and air pockets.

Heightened volatility and ultra-low yields have also pushed investors to look beyond traditional asset classes. With correlation between traditional equities and fixed income, as well as across geographies, nearing all-time highs, investors are coming around to the benefits of diversification, potentially enhanced returns, and risk reduction through alternative assets as well as strategies such as short-selling, use of derivatives, and leverage.

“Despite being a relatively new asset category, alternative ETFs have grown significantly, gathering $2.2 billion in AUM along with a flurry of new product launches in the last three years,” Kanagasingam said. “As of May, liquid alternative ETFs have generated $841M in net sales YTD. As an innovator in Canada’s liquid alternatives space, CI GAM stands today as the largest liquid-alt provider in Canada, with $3 billion in total liquid-alt AUM and alternative ETFs representing 23% of assets in the Canadian space overall.”

Equity ETF inflows are also reflecting the continuing rotation in factors. The tech-driven growth factor has given up ground to value stocks, including cyclical sectors that have benefited greatly from the reopening. The size factor has also seen a resurgence as small caps have outpaced large-cap stocks over the past several months.

“Historically, both the value and size factors tend to outperform coming out of a recession, and we’ve seen this rotation play out since Q4 2020,” Kanagasingam said.

As energy and financial sectors showed strong performance amid the recovery, Canadian equities had the strongest returns among developed markets during the first half of 2021, making Canadian equity ETFs a fairly popular category. U.S. equities have also powered to new highs, though that’s been undergirded by a rotation toward more cyclical sectors as rising rates sapped some performance from the technology sector.

Cyclical sector performance has also unfolded to the benefit of international large cap equities, particularly in Europe and Japan, where manufacturing picked up and a steeper yield curve supported outperformance in financials; CI GAM’s Japan Dividend ETF, Kanagasingam said, has been among their best-selling ETFs so far this year. But emerging markets have lagged, dragged down substantially by a selloff in Chinese equities amid concerns of policy tightening and a weaker yuan.

With emerging markets in particular, there's a lot of uncertainty, whether it be geopolitical or more related to concerns surrounding COVID,” Kanagasingam said. “We’re seeing investors going to the sidelines and waiting for the dust to settle before reallocating back to emerging markets.”

Amid all of these market movements and sentiment shifts, Canada’s ETF space has punched above its weight. As Kanagasingam noted, ETFs have captured 32% of total flows into Canadian investment funds, even as they represented just 13% of total industry AUM.

That’s not to discount the importance of mutual funds, however. Through May this year, mutual funds have seen record sales numbers totalling $59 billion.

“ETFs and mutual funds each have their advantages,” Kanagasingam stressed. “Both can play a role in a portfolio depending on an investors’ needs and financial goals.”