Could Canadians be at risk from the ETF rush?

Could Canadians be at risk from the ETF rush?

Could Canadians be at risk from the ETF rush? In the first quarter of 2017, ETFs reached a new record level of inflows, officially making them the world’s favourite fund products. But just like driving a car that has seatbelts but no brakes, rushing into a new investment space without a complete set of protections could be disastrous.

That’s the point driven home by Martin Pelletier, portfolio manager at TriVest Wealth Counsel, in a piece for the Financial Post. He pointed out that while fee disclosure has been a strong point of focus for Canadian regulators, they have lagged their counterparts in the UK and Australia when it comes to imposing a fiduciary standard. This imbalance, he said, could have some unintended consequences for investors.

He noted the pace at which brokers and advisors have exited from higher-fee mutual funds and moved to low-cost ETFs — which he said they did to protect their margins while lowering fees paid by their clients.

“[It’s worrying] when fees become the primary motivating factor to reshape a client’s entire investment portfolio — more so now since there is greater responsibility being placed on brokers and advisers to manage a client’s portfolio risk,” he said.

One big question for him is whether advisors, who may not be qualified or willing to take on a fiduciary duty, can properly manage their clients’ risks. He considered the example of an advisor who placed clients with an average risk profile into an F-class or low-fee balanced fund; a good manager knows to de-risk during market highs by changing stock-bond weightings, switching sector exposures, or using other methods.

Advisors in the current system, he said, may not have the expertise or knowledge to do this. They may not even have the time for it, he said, given that an average advisor might have hundreds of clients.

The supply of ETFs flooding the market may also expose investors to unsuitable products. ETF providers often release new offerings to satisfy advisors, who may find it easier to sell a hot sector. In addition, the sheer diversity of products — Pelletier said there are thousands of ETFs with widely varying features including leveraged ETFs, ones that feature rolling contracts, and others exposed to securities with a high bid-ask spread — makes the space hard to navigate.

“A lot of the potential fallout from the move to ETFs will be flushed out during a market correction, but investors should not wait until then, especially if their entire portfolio is currently being switched to ETFs,” Pelletier said.

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