Canada’s Smaller but Mighty ETF Industry

Smaller but mighty. That’s Canadian ETFs and their market as of 2023, at least compared to that of the United States. But don’t let that size fool you. There is plenty going on up north, and the Canadian ETF market is in the process of making its move.

Canada was home to the first-ever listed ETF (in 1990, three years before the SPDR S&P 500 ETF Trust (SPY) in the United States). It also led the way to bringing the cannabis stock industry to the markets in ETF form.

And while the U.S. has evolved into the global leader in ETFs from a size standpoint, its Canadian counterpart has grown into a solid, sophisticated, innovative industry, with plenty of future growth potential, fueled by a combination of North American stalwart issuers and some progressive domestic firms. This is increasingly catching the attention of financial advisors in Canada. They are starting to accelerate their interest in and use of ETFs, as their U.S. counterparts have done in earnest in recent years.

We need to acknowledge that residents of the U.S. and those of Canada share many similarities in terms of culture, interests, and language. However, there are distinct differences that impact the way in which their respective ETF markets have evolved over the past 30 years. Historically, institutional investors used ETFs primarily as tactical, short-term tools to gain exposure to parts of the liquid markets. However, that usage has expanded more recently, with those investors increasingly seeing ETFs as a way to gain core exposure.

Two Very Different ETF Markets

To better understand the Canadian ETF market on its own and compare it to that of its southern neighbor, the United States, let’s first examine the Canadian industry from a high-level statistical standpoint. Then, we’ll dig a bit deeper into the current market leaders, up-and-coming firms, and the future potential of this market.

The Canadian ETF market has total assets under management of $575 billion in Canadian dollars. Those assets are invested across a total of 1,390 ETFs currently trading. Twenty of those ETFs account for 30% of total ETF assets. Stepping back a bit, 59 ETFs account for 50% of total ETF assets. And 394 ETFs account for 90% of total ETF assets. In other words, like the U.S. ETF market, the Canadian ETF market is highly concentrated, though to a somewhat lesser extent.

Notably, the table above features a fairly large number of ETFs in the “Alternative” segment. This includes option-oriented ETFs, which are at least as established in Canada as they are in the U.S., particularly in the use of option-writing strategies for income.

Canadian ETF Asset Leaders

Among the equity ETFs, we find a mix of Canada-focused and U.S.-focused stock ETFs. There are also international equity funds. Issuers include some names familiar to U.S. investors.

The two largest ETFs are actually two tranches of the same fund — a fixed income fund. The difference between them is the currency denomination. The PIMCO Monthly Income ETF (PMIF.TO), the largest at over $23 billion, is valued in Canadian dollars. However, the $17 billion PIMCO Monthly Income US$ ETF (PMIF.U.TO) is converted to U.S. dollars.

Similarly, the largest equity ETF in Canada accounts for about $21 billion in assets, split among a pair of currency-specific tranches. The Bank of Montreal offers the $12 billion BMO S&P 500 ETF (ZSP.TO), denominated in Canadian dollars. The issuer also markets a second U.S. dollar-denominated tranche (ZSP.U.TO) with close to $9 billion in assets. Vanguard, too, has a Canadian ETF listed that tracks the S&P 500 and is near the top of the asset charts.

Canadians’ Usage of ETFs: Past and Current Trends

Canadians have some distinct investment preferences when it comes to ETFs. Depending on how one looks at it, these are either different from, or just a bit ahead of, investors in the United States. For instance, inverse and leveraged ETFs in Canada date back more than 15 years, almost as long as the U.S. has offered them. And option-oriented strategies, including put and call writing, are not new concepts to that market.

That said, the ETFs devoted to those areas are relatively small versus the equity and fixed income offerings. As in the U.S., investors seem to focus on checking the box on traditional asset allocation approaches. From there, they augment their portfolios with alternative strategies.

Canadian ETFs: Home Ice Advantage?

Canadians tend to feel strongly about their home market. One of the takeaways from VettaFi ETF futurist Dave Nadig’s recent interview with National Bank Financial’s Daniel Straus, head of the bank’s ETF research & strategy group, is a palpable home bias. It is estimated that 90% of Canada’s population lives within 100 miles of the U.S. border, though it is spread out across the country from Montreal to Vancouver.

As of the end of July, the Canadian stock market was only about 3.2% of the MSCI World Index, while the U.S. market, after more than a decade of generally strong returns, has reached nearly 70% of that index’s weight. As a result, U.S.-based investors can be forgiven for having a heavy home-country bias (and they certainly tend to).

However, Canada-based investors need to consider whether they are taking an undue risk in being too Canada-centric. After all, there’s another 97% of the global equity market out there. This is reflected in the size and scope of the equity ETF market in Canada. Canada’s main equity benchmark is the S&P/TSX 60 (TSX is the Toronto Stock Exchange), and there are several large ETFs that track that benchmark.

Among them are offerings from top U.S. ETF providers, such as iShares (XIU.TO), Fidelity (VUN.TO), and Vanguard (VCN.TO). However, Canadians tend to have a closer affinity to their banks. Those banks have capitalized on that by becoming some of the larger issuers of equity ETFs. BMO’s index ETF that tracks the S&P/TSX 60 Index is one of the largest.

TSX 60 vs. S&P 500: Very Different Sector Allocation

Canada is well known as a natural resource economy, though energy (18%) and basic materials (10%). Those sectors have much larger weights in the Canada stock index than the S&P 500 (which weights those sectors at around 5% and 3%, respectively). However, they are perhaps not as dominant as one would expect.

As it turns out, financial stocks (primarily Canada’s five large banks) are the largest weighting in the S&P/TSX 60, at about 34%. The other stark difference between the two North American stock market index weightings is technology. While tech currently dominates the S&P 500 at a 28% weighting, its Canadian counterpart only carries an 8% weighting in that sector.

Homegrown Canadian Asset Management Talent on the Rise

Canadian-based issuers such as Mirae Asset Management, an 18-year-old, Toronto-based firm that runs the Horizon ETF series, and iA Clarington, a $17 billion investment management firm, have and continue to make a mark on their home ETF market.

There’s also Mackenzie Investments. Its tagline, “made for Canadians, by Canadians,” signals the firm’s mission to tap into the domestic affinity for Canada’s TSX 60 Index. The benchmark’s sector differences from the S&P 500 also play into the investment decisions Canadians make when considering ETFs. Given that Canadian wealth (perhaps 85% or more of it) is held by those five big banks, the stage would appear to be set for an expansion of ETF distribution through financial advisors, and with some Canadian-based asset managers challenging the banks for market share.

ETF Industry Says OK, Canada!

Perhaps the outlook for the North American ETF industry can be summarized this way: Don’t sleep on Canada! A tighter population in size and geography, a historical willingness to innovate, and an emerging group of participants spells a bright future for the Canadian ETF market.

As strong as the United States’ ETF industry growth has been, its sheer size inevitably leads to more complexity, in regulation, challenges for smaller providers getting shelf space, and potential fallout from what appears to be a fully valued equity market. Canada’s momentum in the ETF business should merit much more investor attention in the years to come.

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