What’s driving the record-setting boom in ETFs?
With markets soaring this year, equity ETFs accounted for just over half of this year’s record inflows through October.unknown/iStockPhoto / Getty Images
It’s been a record year for exchange-traded funds in Canada. Inflows hit $56.6-billion through the end of October, according to data compiled by National Bank Financial, topping the previous record set in 2021 with two months of sales still to come.
But while in previous years specific forces have attracted money, this year’s flows are more widespread, says Daniel Straus, director of ETFs and financial products research at National Bank Financial Markets.
“The past record year [2021] was the post-pandemic, meme-stock-fuelled insane growth kind of year,” he says.
Many investors were flooding back to the market at that time, he notes, and there were significant flows into speculative areas as well as plain index funds.
“This year there has been a lot of buoyancy in the market,” Mr. Straus says. “There’s bullish sentiment, which has translated into demand for products linked not only to the S&P 500 but the wider stock market.”
With the S&P 500 up more than 24 per cent this year and the S&P/TSX Composite index up more than 21 per cent, performance-chasing may be a factor in the record flows, which are not just a Canadian phenomenon. ETFs have taken in US$1.5-trillion globally, according to Bloomberg Intelligence, with every region seeing record inflows.
Equity funds accounted for just more than half of this year’s ETF inflows in Canada through October. Fixed-income ETFs have gathered $20.4-billion while commodities, multi-asset, leverage and inverse ETFs are also experiencing strong growth.
“Now that interest rates have begun falling, we’ve seen high demand for products that offer yield, including covered-call ETFs,” Mr. Straus says.
Market-cap-weighted ETFs have led inflows, while low-volatility ETFs and ESG ETFs have somewhat fallen out of favour, according to National Bank Financial. Despite inflows in October, financials and energy sector ETFs have seen net outflows this year.
Erika Toth, director for Eastern Canada with BMO ETFs, a division of BMO Global Asset Management, says fixed income has been leading inflows. BMO GAM has been the top-performing fund provider in Canada this year in terms of inflows, according to National Bank Financial, bringing in about $13.7-billion through October.
BMO Aggregate Bond Index ETF ZAG-T, which Ms. Toth calls a “clean and efficient” way to add duration to bond portfolios, had the second-highest ETF flows at $3.5-billion through October.
Ms. Toth says falling interest rates are the main driver for fixed-income ETFs. She notes that in past years, many investors may have been in cash-equivalent funds or guaranteed investment certificates, but now there’s more potential for price appreciation and yield in longer-duration fixed-income funds.
But “plain vanilla” funds tracking the S&P 500 have also seen high demand. Vanguard S&P 500 Index ETF VFV-T led all ETFs with almost $5-billion through October. BMO S&P 500 Index ETF ZSP-T was seventh, pulling in $1.4-billion.
Ms. Toth says some investors are now looking for more specific exposure on the Canadian equity side. For exactly, BMO S&P TSX Equal Weight Banks Index ETF ZEB-T had $649-million flow into it one day in October, she says, making it the fund’s biggest day ever.
“You’re starting to see more flows into rate-sensitive equity sectors that have been beat up over the past few years in the expectation that interest rates are going to trend down,” she says.
In many cases, she says, investors favour ETFs over individual stock and bond selection.
Meanwhile, mutual funds have seen net redemptions of $31-billion as of the end of September, according to the Investment Funds Institute of Canada.
Mr. Straus notes that ETFs began outselling mutual funds in the U.S. in 2008, but that didn’t happen in Canada until 10 years later. In both cases, he says, the changes were mostly because of lower costs.
“We used to hesitate to say whether ETFs are cannibalizing mutual funds,” he says. “But I think that trend is starting to take root now, and investors are redeeming their mutual funds and moving into ETFs.”
Cost is just one reason some advisors are increasing their use of ETFs in client portfolios.
Mary Hagerman, senior portfolio manager and investment advisor with The Mary Hagerman Group at Raymond James Ltd. in Montreal, says she created ETF-based discretionary portfolios following the 2008-09 global financial crisis.
“Industry statistics showed that passive ETFs outperformed most managed products,” she says. “I choose to work with ETFs primarily for performance reasons but also because of their low-cost fee structure and the facility to manage risk in my globally diversified portfolios.”
The proliferation of active and more esoteric ETFs may have added to inflows, but the additions aren’t welcomed by all advisors.
“There have been many changes in the ETF industry, not all positive in my opinion,” Ms. Hagerman says.
She adds that she’s stayed true to her original philosophy of using “low-cost, plain-vanilla ETFs from established providers,” which has produced “robust returns.”