What bond ETF investors need to prepare for

As a decades-long trend ends, investors need to get the right active strategies in their portfolios

What bond ETF investors need to prepare for
Canada’s ETF industry has been going through undeniable and seemingly unstoppable growth. But while ETFs are most popularly known for their passive, index-based flavours, active strategies have also witnessed strong growth.

“Active strategies in Canada have grown roughly tenfold in the last six years,” said Rohit Mehta, president of First Asset Investment Management. “In 2011, when there was $42 billion in ETFs in Canada, 9% was in actives; fast forwarding to today, you have $130 billion in the industry, and 27% is in the active bucket.”

Mehta noted that recent launches and expansions have really been focused on active products and various research firms are also forecasting growth in Canada’s active ETF space. First Asset wants to become the leading provider in that space, and they are working toward that through a deliberate process of development.

“For us, it’s a matter of looking at the landscape,” he said. “Surveying what’s in the market today, the challenges and opportunities, and coupling that with our internal and external strengths and capabilities.”

The firm applied this process to developing the First Asset Short Duration Bond ETF, which launched on the TSX in September. According to Mehta, they saw a need to enable investors to generate fixed-income yield that’s not a result of duration.

“We’ve been in a 30-year, declining-interest-rate environment, and people have been rewarded for taking on duration risk,” he said. “But we’re almost at an inflection point; interest rates can’t get much lower. And when they go higher, strategies that have performed in past environments will not work.”

The firm knew that a traditional rules-based product won’t fill the gap. It had to be an active strategy, and they needed a manager to run it effectively. So they turned to Marret Asset Management. “They have very strong capabilities in the fixed-income space, and they’ve been running a similar product through an offering memorandum,” Mehta said.

The short-duration bond ETF was brought to market as a First Asset product, with Marret acting as the sub-advisor. It has already surpassed $50 million, though expectations are still high; the two firms will work with advisors, whether through branch meetings or through one-on-one sessions, to make sure they’re properly aware of its advantages.

“We’re big believers in the need for advice,” Mehta said. “There’s more choice than ever in the investment industry: navigating that universe, putting all these components together in a portfolio, and making sure that they’re really working together require significant expertise.”

In his view, that expertise is particularly crucial because evaluating ETFs isn’t a simple matter, and advisors are becoming more equipped to realize that. “Advisors are more analytical than they’ve ever been, and part of that is a result of increased technology and enhanced tools to provide that analysis,” he said. “They’re looking at portfolios not just from a one-dimensional return perspective, but also from a multi-dimensional risk and return perspective. I think investors not looking at the risk side could definitely be setting themselves up for surprise and disappointment.”

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