Canadian exchange-traded fund growth continues to hit record monthly highs, with a total of $134-billion in assets currently under management in more than 600 funds, yet misconceptions continue to pop up when it comes to ETF investing.
Industry pundits Daniel Straus, ETF research analyst for National Bank Financial, and Alan Green, head of iShares Capital Markets for BlackRock Canada, sat down on Tuesday during the S&P Dow Jones Indices ETF conference in Toronto to debunk several common myths that exist when trading these securities.
Here's an excerpt of their discussion:
Myth 1: ETFs have liquidity problems.
There seems to be a consensus that investing in ETFs comes with a lack of liquidity. But this is a myth, Mr. Green told a group of financial advisers and portfolio managers. "Even an ETF that doesn't trade can still be liquid," he said.
In fact, the majority of ETF liquidity comes early in the life cycle from market trading in the underlying securities, Mr. Green added.
"As the ETF matures and the ETF assets under management builds, more and more natural secondary-trading occurs, with less reliance on the primary market and underlying securities.
"Liquidity in ETFs is much greater than thought," he said. "The reality is the fundamental liquidity of an ETF is really that of its underlying market." An ETF's average daily volume is not the full extent of its liquidity. Liquidity can be sourced in the secondary market by using execution strategies, such as limit orders, he pointed out. New shares of the ETF can be created by designated brokers accessing the underlying bond market.
Myth 2: Passive investing is taking over the active world
As more discussion arises around passive investing, as well as performance comparisons to active strategies, there appears to be a fear from investors around what a market would look like if the entire industry turned to passive index-based building blocks, which critics claim could lead to mispricing in the market, Mr. Straus said.
But the belief that passive index investing is now being used more than actively managed strategies is far from reality, Mr. Green said. Market research shows that currently the vast majority of assets are not tied to a benchmark and passive investing on a global scale is approximately 10 per cent of all investable assets, Mr. Green said. Domestically, only 6 per cent of the market lies in indexed assets.
"It is making a mountain out of a mole hill, and we could debate the relative merit of the argument that passive is somehow undermining the efficiency of capital markets when ETFs get to the point when they are a significant chunk of all managed assets," Mr. Straus said.
"… Even if we do get to that point – when 50 per cent or even more of all assets are passively indexed – market pricing mechanisms could still be quite efficient because actively managed assets would still dominate actual trading and dollar turnover."
Myth 3: ETFs are affecting the IPO market
The investment industry has expressed concern that ETFs with their passive investing indexes could potentially wipe out the initial public offering market. But when one examines the correlation between the total assets in ETFs and the Canadian IPO market, it is less than 0.03 per cent, according to Mr. Green.
"Trends such as the rise of private equity, the cost and regulatory burden of going public would seem a more reasonable explanation of the IPO trend," he said.