WP talks to Danielle LeClair, director of manager research for Canada at Morningstar
The strong growth of active ETFs in Canada was recently highlighted in a report from Morningstar, revealing stellar 15x growth in the past 10 years, outpacing passive ETFs and mutual funds.
To find out more, WP has been speaking with Danielle LeClair, director of manager research for Canada at Morningstar, to get her take on what’s happening with active ETFs and what advisors need to know about the risks and opportunities.
Firstly, looking ahead to the end of the decade, what does LeClair see as the potential growth of decline factors for these investment funds?
“It is going to come down to any regulatory changes and/or changes in fees,” she says. “Both could push assets into, or cause assets to leave active ETFs, depending on what the change is. If regulation starts to require more transparency (ie: daily), you could see some asset managers back away from active ETFs as a vehicle. Similarly, the price advantage we see in some areas of active ETFs could drive more inflows relative to their mutual fund counterparts.”
The Canadian active ETF ecosystem has a high concentration of assets in a few large funds, but is this a result of investor confidence or a lack of innovative choices?
“The first is that Canadians love balanced funds so any cost advantage active ETFs have in this space will see investors flock to those funds – Vanguard and iShares stand out here the most,” LeClair explains. “The second observation is that the largest asset managers with active ETFs are also the firms with among the largest balanced fund lineups. Many of these active ETFs are either held in a balanced fund or are structured in a way that the mutual fund actually holds the underlying ETF so that bank advisors can still own it through the mutual fund vehicle.”
With a high rate of fund liquidations – Morningstar’s report shows that 25% of all active ETFs have been delisted over 10 years and 66% of closures were due to liquidation - especially for small funds, what risk indicators should advisors prioritize when evaluating an active ETF’s long-term viability?
“Younger/newer funds might take time to grow assets but if flow and assets do not appear to breach the C$100 million threshold after a few years, there might be reason for concerns,” says LeClair. “Funds from more established, stable asset managers will also enjoy better supporting resource than those from smaller and nicher [sic] provider.”
Morningstar’s ETF Primer shows that:
- The median size of an ETF 12 months prior to closing was $11 million.
- Most ETF closed in their second or third year.
- Popular ETFs with over $200 million and that have traded for several years are likely to stick around.
“This [C$100 million] threshold may take longer for thematic and niche ETFs to reach, but even if they do, past Morningstar’s research has shown that thematic fund flows can be cyclical,” adds LeClair. “It would also be helpful for advisors to look into the firm’s track record of launching these types of strategies. If they have had a history of frequently launching thematic/niche ETFs to capitalize on trends and struggling to gather assets & shuttering them after, that’s another red flag.”
How does LeClair think advisors should weigh the trade-off between lower management fees in active ETFs versus potential performance fee structures in alternative ETFs?
“Performance fees can impact mutual funds and ETFs equally,” she says. “In this case, our methodology used an asset-weighted fee which means that the active alternative ETFs investors have gone to have been the ones with higher performance fees. The more important thing to remember here is that performance fees vary and, in some periods, can greatly impact fees.”
Finally, what are the most common misconceptions retail investors have about active ETFs that advisors should address in conversations?
“I would think a common misconception that active ETFs are always cheaper than mutual funds because they are ETFs. There is some evidence that certain sections within active ETFs are cheaper, but that’s not always the case,” LeClair says. “We pointed out Alternatives in the report, but also generally speaking, traditional active ETFs are more in line from a pricing perspective. In some case this is intentional so that asset managers don’t create any conflicts by having the same strategy priced differently – generally active ETF fees match or are closely aligned to the mutual fund’s fee-based share class price.”
