The evolution of Canadian ETF product offerings

IIAC managing director analyses the growth of the industry and its long-term prospects

The evolution of Canadian ETF product offerings

Todd Evans is a managing director at the Investment Industry Association of Canada (IIAC). He analyses the state of the Canadian ETF industry and its long-term prospects.

Exchange Traded Funds (ETFs) have come a long way in Canada since they were initially launched as Index Participation Units on the Toronto stock exchange in 1990. The asset holdings and liquidity of ETFs have grown dramatically in the last decade and, on balance, this growth has held up well through the recent COVID-19 crisis period. While the most common type of ETF is a market ETF which tracks major market indexes like the S&P/TSX, there are many ETFs specialized in different corporate sectors and industry. The more focused ETFs are not surprisingly more volatile in the marketplace.

Industry ETFs that primarily track a given sector index are created to emulate the underlying industry, such as energy, technology, or pharmaceuticals. However, these ETFs often do not exactly mirror the desired industry or sectors performance because their composition is usually slightly different. As of May 2021, equity ETFs accounted for 63% of total outstanding ETFs in Canada and approximately 50% of total monthly inflows. In addition, cap-weighted ETFs accounted for 59% of outstanding equity ETFs and 66% of monthly equity inflows (33% of total monthly inflows). So, while there has been diversification and product development in the ETF space, traditional cap-weighted equity ETFs remain a significant ongoing presence.

As the ETF market has grown and evolved, strategies have become more varied and complex. ETF underwriters have continued to expand and distinguish their product mix to meet investors needs. It must be noted however, that traditional market ETFs still dominate the space and continue to see strong demand. In Canada, with less ability to scale and compete against the broader index trackers, new entrants have emphasized alpha-seeking solutions to distinguish themselves. These ETFs feature actively managed strategies (“non-index tracking”), tracking strategic-beta indexes, employing quantitative models, or providing exposure to a thematic investment mandate.

Non-index tracking ETFs have dominated new product development in recent years, making up 232 of the 486 launches over the three-year period ending December 2018. By comparison, funds tracking strategic-beta and market capitalization-weighted indices accounted for 142 and 112 funds, respectively, over the same period. Ongoing development gave non-index tracking ETFs the lion’s share of the product shelf in Canada, despite this fact index-tracking funds continue to retain most of the current total AUM.

Even as new types of asset classes have emerged, the largest individual ETFs in Canada are also conventional index tracking funds, with equity tracking funds still outpacing fixed income funds in growth and AUM. According to CETFA data “as of December 2019, equity-based ETFs accounted for 66.1%; fixed-income for 30.5%; multi-asset class for 2.5%; commodity ETFs for 0.8%, and currency ETFs for 0.1% of all assets”.

Thematic and alternative strategies ETFs have seen many new launches in recent years, as investors have gained greater familiarity and understanding in these investments, such as strategies that include high interest deposit investments, cannabis, esports and AI investments. There has also been a recent interest in thematic equity ETFs that have investments in environmental, social and governance (ESG) related industries and projects, cryptocurrency and blockchain.

Overall growth in ETF AUM has been rapidly increasing, with many launched in response to expanding investor demand and appetite for a diverse range of products with low transaction costs and fees. The long-term prospects for ETFs in Canada are therefore optimistic and show continuing promise, in part because Canadian investors are increasingly attracted to the relatively lower fees of ETFs.

The current ETF structure in Canada has shown to be robust, liquid and continues to function well, weathering the recent pandemic in impressive fashion, and the ETF space does not currently appear to require any material changes or additional regulation. New ETF product development should and will likely be a function of investor demand as well as proactive new product development initiatives undertaken by ETF providers to continue develop products to meet evolving investor preferences. These new products will offer a wider suite of options but must be accompanied by thorough and thoughtful disclosure.