Dunwoody on Canada’s Seller Marketplace and ETF Industry

The Canadian ETF market is home to the first ETF ever launched globally in 1990. Though today’s Canadian ETF market is smaller than other countries, it remains arguably the most innovative globally. Pat Dunwoody, executive director of the Canadian ETF Association, recently sat down with me. We discussed the opportunities, challenges, and different market structure of Canada’s ETF industry.

“The Canadian Marketplace Was Always a Seller’s Marketplace”

Pat Dunwoody, executive director of the Canadian ETF Association

Pat Dunwoody, executive director of the Canadian ETF Association

Karrie Gordon, staff writer, VettaFi: Pat, I appreciate you agreeing to talk to me. Let me open by asking the question you probably hear the most. What do you view as the core differences between the Canadian and U.S. ETF industry and market?

Pat Dunwoody, executive director of Canadian ETF Association (CETFA): As much as we started the market 30 years ago, it never really caught on in Canada because investors just weren’t as fee-conscious as Americans. It was a hard sell for advisors who were selling either front-end or back-end mutual funds.

What kick-started it were some regulations that came in where the advisors had to start putting more of their fees on the client statements. It made it much clearer, what was expensive and what was cheaper, and underscored the need to be able to justify those choices to clients.

The other aspect is that the Canadian marketplace was always a seller’s marketplace, not a buyer’s. Clients almost without question followed their advisor’s advice — they never asked for more. Why would the advisors change their methodology?

Channels of Distribution

Gordon: That’s really fascinating, and clearly it’s something that is now changing. What do those changes look like?

Dunwoody: We have two channels of distribution up here. They merged recently from a regulatory standpoint, but not yet operationally — the investment dealers (IIROC) and the mutual fund dealers (MFDA).

Historically, the MFDA dealers were always able to sell the product since, under Canadian rules, they are classified as investment funds. But they never had access to the market. So myself, along with the head of the Federation of Mutual Fund Dealers, worked to build out that process that regulators would approve.

In conversations with advisors, we are trying to get them to appreciate the value of fee-based accounts without even mentioning ETFs. Once you’re in a fee-based account, ETFs are simply a natural addition, but it’s a slow slog. We’re seeing real impacts in some firms, but not across the board yet.

I believe that the slower adoption of ETFs really is not related to the product at all, it’s related to the sales process and the channels.

Canada’s ETF Market as the Home of ETF Innovation

Gordon: Pivoting a bit, the Canadian ETF marketplace is often depicted as one of, if not the most, innovative markets globally. Canada was the first to offer a cannabis ETF, and currently has spot bitcoin ETFs, a highly contentious regulatory issue in the U.S. From your perspective, why does innovation seem to take root so strongly in Canada?

Dunwoody: I think the main reason is because ETFs are under the Investment Fund Rules — the same rules that mutual funds follow. We’re blended — as mutual funds came up, ETFs were just a natural addition to that. There was a lot more flexibility for active products, and innovation for both product lines, but ETFs I believe took advantage of the innovation a lot more.

I also think our industry has a good working relationship with the regulator. We explain a strategy and then we walk them through it. As long as they’re comfortable with the strategy and comfortable with the disclosure regarding the risks and the costs, they are comfortable with the product. Now, with the future potential changes, we’re not sure, but I think we will stay at least partially under the Investment Fund Rules, which will continue to provide us flexibility.

The Popularity of Active Strategies

Gordon: I’m glad you brought up active strategies, actually. The active versus passive debate is an ongoing one here in the U.S., but that’s not the case in Canada. Active ETFs make up over a quarter of all ETF AUMs in Canada as of the end of the first quarter this year. Why is active so big?

Dunwoody: It started with availability because the rules were there. Every two or three years, the regulators would investigate as to whether we should have intraday pricing. We actually had a few members that would include it on their website, but it was never viewed. We have been able to allay any concerns that the regulators had.

Showing intraday pricing is a huge expense, and it’s not terribly accurate for products with holdings outside of North America. If the pricing is accurate, the spreads are good, and the ETF issuers monitor the market makers continually to ensure the spreads are as narrow as possible; there’s not an issue. We believe there’s no additional advantage to having intraday pricing, and it could just be a substantial cost.

Also, because we’re under the mutual fund rules, it would be almost impossible for them to have ETFs to show their portfolios more often than a mutual fund. Since our industry is more tuned towards the mutual fund side, no one is expecting to see those kinds of disclosures on a daily basis.

Increasing Interest in Derivatives

Gordon: Speaking about specific strategies, single-stock ETFs and derivatives are gaining momentum and investor interest here in the States. Are you seeing a similar trend in Canada’s ETF ecosystem?

Dunwoody: There are a few single-stock ETFs now, but not many because I don’t think clients and advisors have got their heads around them yet.

Derivatives though, we are seeing more just because it lessens risk. I think people are now thinking more about upside and downside risk as opposed to just risk. Our risk ratings up here are 10-year rolling standard deviation. Recently, high savings interest accounts (HISA) have gained huge momentum in terms of asset collection. People are looking to park their money right now because they don’t know where things are going.

Canada’s ETF Runway: Opportunities and Change

Gordon: Looking big picture again, in the U.S., ETFs make up between 23%-25% of AUM. In Canada, that’s around 14%. What opportunities do you currently see for Canada’s market?

Dunwoody: Historically, the first seven or eight years of the flow into ETFs was new money. It wasn’t transferring in from mutual funds, but we’re starting to see that. We always had institutional money, but I think we’re starting to see more of that now, specifically on the bond side, because it’s an easy way for them to adjust their portfolios.

From the advisor side, they needed to be able to justify to the client the potential to take a capital gain hit, or a fee hit. They needed a reason to make the switch to ETFs.

I think the retail side has really picked up in the last three to five years specifically. Advisors are really starting to look at ETFs now. Our market here is based on being sold, not being bought. We have to convince the advisors to make that switch. The more we can market, educate the users, and show the advantages of using ETFs, we’re seeing that reflect in sales. It’s a slow uptake though.

Gordon: It makes sense that advisors would be the linchpin on a lot of this because Canadians in general use advisors at a much higher percentage than in the U.S. Looking at ETF adoption from a different angle, do you see ETFs changing the nature of Canada’s advisor industry?

Dunwoody: Absolutely. I think we’re going to see an increase in fee-based accounts which levels off advisor revenue.

Up here, on a mutual fund side, an advisor earns a lower fee for assets held in money market or bond funds. If the advisor uses fee-based accounts, their fees are based on assets — regardless of investment. I also think we’re seeing more advisors flipping to asset-based accounts because it’s easier for them to sell their book. As the advisors get closer to their retirement or close to the point where they want to sell their book, we think that will be even more common.

Challenges to Canadian ETF Adoption

Gordon: That’s an interesting potential trend to keep an eye out for in the coming years. This has been really wonderful Pat. One last question before we go — what roadblocks to increased ETF adoption do you foresee for Canada’s market?

Dunwoody: Education. I was speaking to a president of one of the smaller dealerships this morning and they really got an uptick in assets. They said that advisors still don’t quite understand sometimes how ETFs fit in their client portfolios. Operationally, they’re different than what they’re used to. They’ve asked for a presentation of a case study to help them overcome the cost objections. They have to be able to speak to their client about what it’s going to cost them.

Another core issue is placing orders. With mutual funds, you just put in the order whenever as long as it’s before close. With ETFs, the regulators expect advisors to follow best execution rules. You can’t just take an order from a client and eventually get it in. What’s happening is that some firms are setting up their operations now to allow for ETF trades. However, they’re having to ensure there’s always someone licensed in office to be able to put the trade through.

The other component is the MFDA (Mutual Fund Dealer Association). As the mutual fund dealer channel is bringing together the rules between it and the IIROC channel under the new SRO, the Canadian Investment Regulatory Organization (CIRO), it’s a really slow process — understandably. It’s frustrating for us because there are some limitations on competence training and education. Once we know the timeline, we can work towards that. So it’s really education and then operational issues that we’re still working through.

Canada’s ETF Comparisons

A last thing to touch on is that we don’t have an easy way to compare ETFs. There are ETF fact sheets, but for understanding costs differences and why one equity product is different than another, we point advisors to the two exchanges up here that have ETF great screeners.

In the case of mutual funds, I think they just go to the company and they trust them. Whereas with ETFs, it could be almost the same name of a product but have substantively different portfolios. Maybe it follows a different index, or uses slightly different factors. It’s more than a nuance, and they have to appreciate all those small changes.

Gordon: Pat, thank you again for your time and for this wonderful insight into Canada’s ETF market.

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