Asset Allocation, Asset Managers, Consultants, Defined Benefit, Endowments/Foundations, ETF, Institutional Investors, Pension Funds, Public Funds

Canada Leads the ETF Charge

Canadian institutions are at the forefront of a growing move by institutions worldwide to integrate exchange-traded funds (ETFs) into their portfolios, according to the 2017 Canadian Exchange-Traded Funds Study, recently released by Greenwich Associates. In fact, the 52 Canadian institutions that participated in the study currently allocate an average 18.8% of their total assets to ETFs—the highest average allocation found in any of the five regional markets covered in Greenwich’s studies. That’s an increase of 3.5 percentage points from 2016.

By comparison, Asian institutional participants in the Greenwich Associates 2017 Asian Exchange-Traded Funds Study said their allocation to ETFs actually declined slightly, to 14% 2017 from 17% 2016. Average ETF portfolio allocation among the institutions participating in Greenwich Associates European Exchange-Traded Funds Study increased to 10.3 % of total assets in 2017, from just 7.7% in 2016. Across Latin America, institutions increased their allocations to ETFs to 13.1% of total assets in 2017, from 7.6% in 2016, according to the Greenwich LATAM study.

Canadian institutional investors have been growing their use of ETFs by “leaps and bounds,” said Bobby Eng, head of SPDR ETF business development-Canada at State Street Global Advisors. One of the reasons is the level of knowledge and expertise that Canada’s pension plans have around these products. “Canadian pension plans tend to be more sophisticated with internal investment management and trading capabilities,” Eng said.  They also do most of the strategizing and investing in-house. “Most of the largest pension plans have their own trading desks, portfolio managers, and analytics and research teams compared to others who may outsource to third-party external managers,” he said. “This enables them to use ETFs more.”

Andrew McCollum, Managing Director, Greenwich

The widespread use of ETFs in Canada may also be due to the fact that the first ETF was created there. Its widespread adoption as a strategic tool, rather than just for tactical purposes, took hold in the U.S. and Canada well before European and Asian investors caught on to its variety of uses, posited Andrew McCollum, managing director at Greenwich and author of the report.

Zev Frishman, chief investment officer at Toronto-based consultant Morneau Shepell Asset and Risk Management has also seen a rise in investment in fixed income ETFs in Canada. “In fixed income, we’ve seen growth in the passive or broad universe tracking fixed income ETFs” he said. “Canadian funds commonly use variations of the Canada universe bond indices (total universe or short term only; federal, provincial or corporates) or global indices (investment grade, high yield or emerging markets debt – unhedged or hedged to the C$) because you can tailor them to your needs. If you believe rates will rise, you can buy a short term index, if you want to bet on rates declining you can go to the long end. You can do maturity or duration management with passive ETF indices as well,” he said.

Canadian pension plans tend to be more sophisticated with internal investment management and trading capabilities.

Fragmentation in the ETF market

The sheer number of ETFs being offered in Canada has caused fragmentation in the marketplace, however, according to Jack Bensimon, Chair of the Ontario-based, Technion Canada endowment fund. “Although Canada was the pioneer of very first ETF, the market has become highly commoditized and fragmented, with far too many funds for the marketplace to absorb. There are over 28 ETF providers with over 80% of the market dominated by two providers. This is acute in a small market such as Canada,” he explained. For that reason the endowment doesn’t use ETFs alone for risk-reduction purposes. “It’s too competitive a landscape to look at just that particular instrument to control volatility and risk,” he said.

Strategic use of ETFs

A growing number of Canadian institutions are using both fixed-income and equity ETFs for the first time in both domestic and international markets, according to the Greenwich report. The consultant credits the versatility of ETF products as the primary driver of their increased institutional uptake. “At the strategic level, Canadian institutions are increasingly using ETFs to obtain “core” investment exposures and diversification benefits,” the report said.

Technion Canada increased its fixed-income ETF allocation in the last two years in order to pick up more yield in the current, low interest-rate environment and to reduce equity price volatility and risk. “We have a fixed spend-ratio and a fixed target rate-of-return, so it’s been very challenging trying to hit those target rates-of- return,” Bensimon said. “We have opted to go for more fixed income and are scaling back on the equity allocation, because of more volatility and a few other factors,” he said. The fund has a 60% / 40% fixed income/equities mix, currently. “We are using indexes to manage risk, including fixed-income ETFs, and over the last 12-to-15 months have increased our fixed-income ETFs by a small margin, mainly tactical allocations,” he said.

Use of ETFs by Canadian institutions increased overall last year in each of 10 primary portfolio functions covered in the study. Study participants said they liked the product’s:

  • Ease of use, the fast execution of trades
  • Liquidity
  • Simplicity
  • The ability to trade them relatively cheaply

“These features make ETFs flexible enough to be applied to a fast-expanding list of portfolio applications,” the report said.

Bensimon concurs, noting that the Technion Canada fund likes the lower management expense ratio and liquidity ETFs provide, and how they facilitate relatively easy replication of a given index. “ETFs provide for a fairly easy and efficient way to diversify a portfolio in a given sector,” Bensimon said. “It makes sense to get exposure to that sector in a cost efficient way with liquidity.”

Study participants

Between October 2017 and January 2018, Greenwich Associates interviewed 52 Canadian institutional investors for its annual study. The 2017 research sample includes a wide variety of institutional respondent types. More than half the participants (48%) are asset managers. The remainder of the research universe includes endowments, foundations, corporate defined-benefit plans, public pension funds, insurance companies and insurance asset managers, along with representation from family offices, investment consultants, and other segments.

Most study participants are large institutions. Approximately 45% of the institutions in the study have assets under management of $5 billion or more, and more than 1 in 5 have AUM topping $50 billion.

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