Strong finish for ETFs in 2023 as fixed income leads annual flows

ETF assets under management in Canada ended 2023 at a new all-time high as markets rebounded and steady flows from investors continued, particularly into fixed-income funds.

After $38.4 billion flowed into Canadian ETFs last year, industry assets totalled $383.2 billion, according to a report from National Bank Financial. That’s up from $314 billion at the end of 2022, when historic drawdowns in both stocks and bonds led ETF assets to dip for the first time in 20 years.

ETF gains came amid another down year for mutual funds, with redemptions totalling $51.9 billion as of Nov. 30 (full-year data will be released later this month). The outflows have allowed ETFs to gain market share, the report said, with ETF assets now totalling almost 16% of mutual fund assets.

Fixed-income ETFs led flows for the second year in a row, gathering a record $21.4 billion in new assets.

“The common thread of demand is still cash-like or money market ETFs, which were 44% of total fixed-income ETF flows, the largest inflow segment by far,” the report said.

Another 40% went to broad-based bond ETFs while 17% went to long-term funds, which suffered most as interest rates rose in 2022.

“While cash-like ETFs remain popular, many investors have started to swim to the deeper end of the duration and credit pool searching for opportunities that may have been beaten up during the brutal bond year of 2022,” the report said.

As rate expectations shifted in November, flows into money market and cash alternative ETFs decelerated and turned negative in December as investor appetites changed.

A report from TD Securities attributed the decline in popularity of high-interest savings account ETFs to stricter liquidity rules announced in late October that take effect at the end of this month.

The higher requirements led to concerns that ETF issuers would be forced to lower the interest rates offered on the funds — concerns the TD report said have been borne out.

While gross yields of around 5.10% for Canadian-dollar ETFs and 5.40% for U.S.-dollar products are still attractive, TD said, “these yields are already 30 to 40 [basis points] lower than the pre-review levels. As a result, investors are perhaps hesitant to pump more money into these products given potential changes in yields.”

Cash ETFs dominated inflows, but National Bank called target-maturity bond ETFs — which have a specified maturity date when the final net asset value is returned to unitholders — the “rising stars” of 2023. The funds, which have existed since 2011, doubled in size last year to $2.4 billion.

The report said advisors were likely using target-maturity ETFs “to minimize interest rate risk while mimicking individual bond investments.”

Equity ETFs brought in almost $13 billion, according to National Bank, surging in the end-of-year market rally after a slow start. Despite the strong performance, U.S. equity ETFs saw the smallest inflows ($641 million) in a decade.

Option-based ETFs (largely covered-call funds) attracted $4 billion for their best-ever year, bringing the category total to $19.8 billion.

Asset allocation ETFs, meanwhile, recovering from a historically bad 2022 for 60/40 portfolios, took in a steady $3 billion last year, according to the report, while ESG ETFs gather $4.6 billion.

There are now 40 ETF providers in Canada offering 1,339 products, National Bank said.

Four providers left the ETF market last year (Smartbe, NCM, Evermore and Emerge), while two new issuers — Forstrong and Tralucent — launched products.

And while there were 164 new ETFs launched, 2023 saw a record number of delistings, at 122 — more than triple the 2022 total. National Bank attributed the closures to the four providers exiting the market as well as significant “pruning” of lineups from Invesco Canada Ltd. and CI Global Asset Management.

Looking ahead, TD Securities said fixed-income ETFs may be less attractive if central banks begin to cut interest rates, a move that could further boost equity markets. On the product development side, the report suggested issuers may appeal to yield-hungry Canadian investors with more enhanced products.

TD also noted that the integration of self-regulatory organizations in Canada could further boost ETFs and narrow the asset gap with mutual funds.