Taking a closer look at Canadian ETFs' record-breaking year

The growth-value matchup, inflation preparations, and the hunt for yield are just some trends that have defined 2021

Taking a closer look at Canadian ETFs' record-breaking year

The past year has seen phenomenal levels of continued growth for Canadian ETFs, with inflows reaching $48 billion to the end of November – easily surpassing the $41-billion record set in 2020 – and on pace to eclipse $50 billion by the end of 2021. But far from being a homogeneous tidal wave of investment, Nirujan Kanagasingam, Vice President of ETF Strategy at CI Global Asset Management sees a rising tide made up of ebbs and flows across different sectors.

“Late last year, and the early part of this year, we saw a resurgence in value stocks as they rebounded and started to outperform growth names,” Kanagasingam told Wealth Professional. “But over the course of the year, we’ve seen the growth markets stabilize and outperform value on a year-to-date basis.”

Peeling back the layers, Kanagasingam said that growth’s outperformance has really manifested most strongly in the large-cap segment of the market, while value companies have shone in the small- and mid-cap segments.

Sector-wise, cyclical industries like financials and energy have done very well, with energy being the best-performing sector globally. Still, the strength of tech stocks has remained largely intact as they took second place in sector performance, though that will be tested with the increasing likelihood of higher interest rates going into 2022.

From a geographic perspective, Kanagasingam says 2021 has been a tale of two halves. The first six months saw Canada among the best equity markets for investors in developed markets. But with the waning of the energy sector tailwind that had propelled it, the Canadian stock market has given up some of its momentum during the second half.

“Year-to-date, Canadian equity benchmarks have outperformed international equities, though they still slightly lagged U.S. indexes,” he says. “Even from an ETF flows perspective, we’ve seen noticeable activity into non-U.S.-focused equities, particularly Canadian equities. Given the stretched valuations in U.S. stocks and fears of rising interest rates, investors are starting to diversify into other geographies, and I think this theme will continue into 2022.”

With decades-high records of inflation readings reported in recent months, as well as persistent supply chain bottlenecks, there’s little doubt among investors that rising prices are here to stay. With that in mind, Kanagasingam says, investors are increasingly looking at commodities such as energy and gold for inflation protection in their portfolios.

On the equity side, ETF investors have been taking a hard look at real assets, particularly REITs and infrastructure, that can draw from the pricing power of their underlying physical investments. Fixed-income ETF investors, meanwhile, have shown interest in TIPS and real-return bonds – which have gathered more than $350 million in net flows in 2021 after lying dormant for several years.

One defining trend for 2021 has been the rise of ESG ETFs, with nearly 70 now listed in Canada after 39 were launched this year alone. The surging demand is also evident from the nearly $5 billion in flows attracted by such funds, more than double the $1.8 billion logged during the 2020 calendar year.

And after the world’s first bitcoin ETF burst onto the scene in February, crypto asset ETFs have emerged as a category to watch. Among the 200 different ETF tickers that were launched in 2021, the top two in inflows were into crypto-focused funds, and nearly $6 billion in inflows have gone to bitcoin and Ethereum ETFs.

“Demand has been coming in from diverse channels. It's been from institutional investors. It's been driven by direct investors,” Kanagasingam says. “And there's also been interest from the advisor segments of the market, which speaks to the power of ETFs to provide everyday investors with simplified exposure to a complex, new asset class. We’ve seen the U.S. launch a futures-based bitcoin ETF, and we think this space will continue to grow.”

As investors continue to hunt for yield in a low-interest rate environment, investors are displaying more interest in covered-call ETFs; even though they give up some upside, the covered-call writing strategies have enabled investors to get attractive yields overall, even from typically dividend-weak sectors like technology or materials.

And while the past decade has been very conducive to pure passive or beta ETF strategies, Kanagasingam says current market conditions – the potential for interest rate hikes, record-high inflation, and ongoing volatility – could pave the way for active and smart-beta strategies to stage a comeback.

“We've already started to see that to a certain extent this year, especially on the fixed income side. A lot of investors have gone into active strategies, where the manager can manage their levels of duration and credit risk exposure,” he says. “In the Canadian space, a sizeable portion of fixed income flows have gone into active ETFs, which is quite startling especially versus years past. I think this interest in more active strategies will continue on both the fixed income and equity side.”