ETF product trends to watch

Fixed income products led ETF growth in the first half of 2019, and the category is expected to outpace equities for the rest of the year, says David Stephenson, director of ETF strategy for CIBC Asset Management.

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“On the fixed income side, passive Canadian aggregate bond exposure has seen very strong inflows, while active fixed income remains popular with investors as well,” Stephenson said in a June 25 interview.

In the first six months of 2019, $10.8 billion has flowed into ETFs, according to data from the Investment Funds Institute of Canada (IFIC), more than half of which has gone to fixed income funds.

The $60 billion invested in fixed income ETFs accounts for roughly one-third of the total ETF market, and Stephenson said that’s likely to grow.

“People talk about the growth of ETFs in general, which has been about 25% compound over the last 10 years, but fixed income is growing even faster,” he said.

Within the fixed income category, he said active funds—which currently account for about one-quarter of the fixed income ETF market—are likely to gain in share.

“Investors are looking for outcome-oriented products in fixed income to help them navigate markets, whether they are concerned about equity market valuations, low yield, interest rate increases, or just outsourcing to the ETF manager where to find the best opportunities,” Stephenson said.

On the equity side, he said there’s been interest this year in low-volatility factor products, U.S. exposure and balanced ETFs. Over the next three to five years, he expects thematic areas such as infrastructure and environmental, social and governance (ESG) ETFs to grow.

Equity funds saw $3.3 billion in net sales in the first half of the year, according to IFIC, while inflows to balanced funds topped $1 billion. While this year’s equity ETF inflows are roughly half of net sales in the same period last year, flows to balanced funds are up significantly from $677 million in the first six months of 2018.

Active versus passive in fixed income

Passive funds offer low cost (investors can get broad exposure to the Canadian bond market for nine basis points), diversification and transparency, while active funds can help investors avoid pitfalls and find opportunities, Stephenson said.

“An example could be investing in a fallen angel that has fallen into non-investment-grade, yet still offers a compelling investment opportunity,” he said.

Active funds can also help navigate an “opaque” bond market, he said, by assessing new issues or taking advantage of compelling valuations.

An active strategy can also help to manage interest rate risk.

“An active manager can adjust a portfolio duration to protect capital by keeping duration shorter than the broad benchmark in an increasing rate environment, or higher in a decreasing rate environment to add value,” Stephenson said.

“The key is flexibility to add value in both rising and declining rate environments.”

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