ETFs continue to gather steam

The net inflows into ETFs versus traditional mutual funds continues to be quite large, to the point that ETF providers are not asking if but rather when will ETFs hit $100 billion in assets under management in Canada?

According to Investor Economics, there are currently 104 Canadian sponsored ETFs across the five major sponsors in Canada representing nearly $29 billion in assets under management at the end of this September. That’s a $29 billion increase from around $19.3 billion at the start of this year. The product class has seen roughly a 50% growth in the last year.

If things continue at this rate it’s conceivable that ETF assets could end up somewhere between $75 billion and $100 billion within the next few years, says Heather Pelant, the head of iShares, Canada, the dominant market player in Canada’s ETF industry. The company controls than 80% of the market share.

“Investor Economics did a project about a year and half ago that had ETFs producing a 21.3% compound annual growth rate. They are fastest growing vehicle in Canada. We projected that out, which pegged ETF assets somewhere around $73 billion in two years,” she says. “I think if the U.S. goes to a trillion AUM — which it will — Canada will be at $100 billion, since we have a market about 10% the size.”

iShares says ETF assets hit an all time high of US$891 billion at the end of August 2009 which is 3.9% above the previous all time high of US$858 billion set in July 2009. The global ETF industry had 1,773 ETFs with 3,137 listings and assets of US$891 billion from 95 providers on 41 exchanges at the end of August 2009.

Some of the growth can be attributed to the strong rebound in the equity markets but the net inflows into the industry continue to be impressive. It’s difficult to do an apples to apples comparison of how well ETF sales are doing versus traditional mutual funds, since the mutual fund sales tracking body – the investment funds institute of Canada – does not track ETF sales.

iShares makes the case that ETFs are handily beating mutual funds in net sales.

In the nine months ending September 2009, net redemptions of mutual funds in Canada were CAN$800 million, according to the Investment Funds Institute of Canada (IFIC), compared to CAN$3.0 billion in net sales of iShares ETFs, and CAN $5.9 billion in total net sales of ETFs over the same period.

Although the scale of the Canadian mutual fund industry can’t be discounted, in the sheer volume of money, it represents well over $500 billion in assets. While $5.9 in net new sales is impressive, just the domestic fixed income fund category of mutual funds alone has had $5.62 billion in sale year to date. What the ETF industry has not had to contend with is long periods of net redemptions.

Pelant says more investors — and more importantly advisors — are increasingly buying into the argument that over longer period of times a mutual fund will have a difficult time outperforming and index benchmark. For investors who buy into this argument, the substantially lower fees on ETFs preserve a greater proportion of their returns.

“In the past, our assets were predominantly institutional, so it was probably a 70/30 split, with 70% being institutional and 30% being retail. Over the last year or so we are getting seeing more of a 50/50 split. On the fixed income side, of lot of our sales have been retail sales,” she says. “Clients are afraid their heading into a low return environment. They don’t want the fees eating up into their returns and they want their advisor to help them construct a portfolio of ETFs.”

Pelant says you can usually tell retail investors are buying certain ETFs based on the order size. In the case of fixed-income ETFs her firm offers, the majority of orders are appear to be retail assets, which are generally held longer.

Fixed income is a huge growth asset class for the industry in terms of sales. Fixed income ETFs experienced the highest growth during that period with CAN$2.4 billion in net new assets and asset under management growth of 100%.

“The fixed-income orders tend to be around a 100,000 shares. This tells me it’s a buy and hold person buying fixed income, because they do hold. We do see if they leave the fixed income products, they tend to move to other fixed income ETFs,” she says. “XBB is our broad bond index, sort of the granddaddy of fixed income ETF, it’s the first fixed income to beat billion. Eighteen months ago, our corporate bond fund was $50 million and it is now it’s over $1 billion. It is almost inconceivable the rate of growth we have experienced in that asset class.”

(10/30/09)