Exchange-traded funds (ETFs) have come along way since they were introduced in the early ’90s. Originally developed for institutional investors, today, there are more than 4,700 exchange-traded products and $2 trillion in assets globally.
Som Seif, president and CEO of Purpose Investments Inc., attributes part of this growth to greater awareness and education. The 2008 financial crisis reinforced the importance of liquidity, which has drawn attention to the ETF structure, he said, speaking at Canadian Investment Review’s ETF Summit in Toronto last week.
Another reason for the massive growth has been the trend toward a passive and active investing blend. “We have to get past this idea that this is an active versus passive debate,” said Seif. “It is an active and passive market; not everything is passive and not everything is active. Segmenting where active matters and segmenting where passive matters is where we can save fees.”
While pension plans use ETFs mainly for cash management and transition, Yves Rebetez, managing director and editor of ETF Insight, said that doesn’t meet all of the needs of plans out there. ETFs are not necessarily a transition vehicle (i.e., a place where a plan can “park” the money while transitioning between managers), he said, there are a great many solutions that are underutilized (think portfolio completion or hedging).
Seif agreed, adding that ETFs can be used for short- medium- and long-term investment objectives. For example, the Canada Pension Plan has bought emerging market ETFs to get exposure in the space.
Similarly, the CAAT Pension Plan (which has been using ETFs since 2009) has had an investment in an emerging market ETF since 2010. “We were thinking of that as a temporary solution, but it’s been with us now for a couple of years,” said Asif Haque, director, investments, with CAAT.
Anthony Martinello, manager of Independent Electricity System Operator (IESO) Pension Plan, which hasn’t entered the ETF space yet, said that IESO is close to using ETFs as a transition vehicle.
But whether used as a transition vehicle or not, ETFs are a convenient and quick way to get the exposure the United Church of Canada Pension Plan wanted in emerging markets, said Dan Foster, the plan’s investment manager.
Haque concurred. “[ETFs are] easy and efficient to get in and out of. And we don’t rule out [using] ETFs in the future in different parts of the fixed income space.”
Rebetez said that ETFs can help plans with the democratization of access. “You can access areas that you formerly didn’t have the ability to access as readily and as easily, and on a cost basis that is generally attractive.”
Using an ETF was an easy and convenient way for the United Church of Canada plan to get exposure, but Foster said he had trouble with the mechanics.
“The toughest part was buying the things,” he said frankly. “We are a small plan, just over $1 billion. I thought this was going to be like buying at a discount brokerage online—you just hit a button. For plans or investors that aren’t doing their own trading, how do we physically get our hands on these things?”
Rebetez was sympathetic. “It’s surprising in this day and age when someone wants to execute a trade and it’s not as easy [to do],” he said. “The channels and access maybe aren’t as open and accessible from an end user point.”
Then there’s the cost. Foster said he would like to see a flat fee, not so much per share for commission rate.
Regulations
From a regulatory standpoint, Canada is a great place for ETFs. “We have proper regulations around the use of swaps and derivatives; and our securities lending rules are tightly regulated,” said Seif. “There’s very little room for manipulation.”
However, outside Canada, it’s a different story. The U.S. has different rules around securities lending (e.g., it allows for third-party lending and lending up to 100% of a portfolio). “Who is guaranteeing that loss?” asked Seif.
In Europe, it’s more of the same. There are relaxed restrictions around what is collateral and securities lending practices, he said.
The industry will continue to see the value of ETFs and their increased use in portfolios, explained Seif. But, he stressed, ETF providers need to address the perception of higher fees (relative to other strategies, pooled funds, futures), as well as increase product understanding by ensuring that investment managers are fully educated about how ETFs can be used. That way, they can be more than just a “parking spot.”