Canada's ETF industry reached $100-billion in asset this spring, but there's another more subtle indicator of the power of this steadily growing investment product.
It's the dismal performance of the shares of companies in the mutual fund business. Let's be clear about mutual funds – they have a total of $1.2-trillion in assets in Canada and they're not going anywhere. Nor should they. When they blend skilled management and reasonable fees, funds have a lot to offer.
But, clearly, investors do not see great things ahead when they look at the shares of companies like AGF Management (AGF.B), down 23.4 per cent annually over the past three years; IGM Financial (IGM), down an annualized 8.1 per cent over that period; and CI Financial (CIX), down an annualized 2.5 per cent. CI has a decent 4.6 per cent five-year return, but the others are in the red over that period.
Part of the story behind these results is the dominance of the banks in the fund business. Every bank branch is a mutual fund sales office that you can walk into off the street. The other fund companies have their adviser sales network, but that's a second-best way to build assets.
ETFs also have to figure into the thinking of anyone assessing the long-term prospects of the mutual fund business. ETFs are much cheaper than mutual funds for investors to own, even after you add the cost of advice. The number of investors latching onto this reality is rising slowly, but steadily. My sense of millennial investors is that they definitely get the ETF advantage on costs.
The higher fees on mutual funds drag down returns to a point where ETFs often perform comparably or better. You get a strong likelihood of competitive returns with an ETF that tracks a benchmark stock or bond index. Mutual funds are full of uncertainties – will good managers keep up their results, will they leave for a competitor, will their brilliant strategy be outflanked by unforeseen events in the markets? Some mutual funds are consistent gems, but many are flotsam that exist only to squeeze fee revenue from investors. Why advisers sell these funds is one of the great mysteries of our time.
As the investment industry moves more toward wider adoption of a fee-based model, ETFs are going to hit their stride. Advisers will charge 1 to 1.5 per cent for their services and then strive to build portfolios that don't cost investors a lot extra. Many mutual funds have management expense ratios above 2 per cent. Here, I show you how to build a simple ETF portfolio with fees of less than 0.15 per cent.
There used to be a saying that investors should buy the shares of a mutual fund company, not its funds. The 2016 version is to just buy ETFs.
Rob Carrick