Non-Transparent Actively Managed ETFs A Revolution in the Making Exchange Traded Forum 2013 Toronto May 2, 2013

Transcription

1 Non-Transparent Actively Managed ETFs A Revolution in the Making Exchange Traded Forum 2013 Toronto May 2, 2013 Jeffrey Shaul, CFA, FCSI, President and CEO

2 The Coming Revolution in Actively Managed ETFs Actively managed ETFs launched by traditional mutual funds could be the next wave of growth in ETFs Will revolutionize the mutual fund industry Multiple industry trends suggest 2013 could be turning point Transparency is key hurdle, especially for equity funds Rules in Canada differ from those in the US, so the revolution could start here before the US 1

3 ETF Asset Growth in Canada Since 2000 ETF AUM (C$ Billions) $60 # ETFs 300 $ $ $ $ $10 50 $ ETF AUM $6.0 $4.9 $5.4 $7.1 $8.9 $12.3 $15.1 $17.8 $19.1 $30.1 $38.2 $43.2 $56.4 # ETFs Source: Canadian ETF Association (Investor Economics) 2

4 ETFs in Canada Current Stats ETF asset growth $13.2 billion (30.6% increase) in 2012 current level $59.5 billion (Mar 31/13) ETF asset growth rate 3.3x that of open end mutual funds, mostly through new creations ETFs still only 6.6% of Canadian mutual fund assets (Mar 31/13) (compared to approximately 10% in US) Broker survey in % of brokers reported ETFs represent less than 10% of client assets potential for growth Source: CETFA / IFIC 3

5 ETFs in Canada More Current Stats Fee disparity mutual funds (2.3% MER) vs. ETFs (0.50% MER) Majority of Canadian ETF assets in equities Passive index based ETFs dominate actively managed ETFs represent only 6% of industry AUM ETF investors in Canada 65% retail / 35% institutional (and roughly 1/2 of retail is discount brokerage) 4

6 ETF Industry Trends Increasing use of ETFs as core elements of buy and hold portfolio strategies Active strategies are growing rapidly fundamental, smart beta, factor indices, covered call e.g. BlackRock new factor-based, enhanced beta Wisdom Tree fundamental indices-based 5

7 Trends in Canada MFDA vs IIROC Mutual fund AUM in MFDA declining as % of total mutual fund AUM Number of mutual dealers declining Mutual fund reps moving to IIROC firms greater flexibility, choice in investments Compliance costs forcing move to larger IIROC firms 6

8 Trends in Canada Trailing Commissions Trend towards advisor compensation based on assets removes disincentive to invest client assets in ETFs CSA looking at advisor compensation, particularly trailing commissions (CSA December 2012 Discussion Paper, planned June roundtable) There is support for dismantling the current structure of mutual fund fees i.e. separate fees for fund management and investment advice (Steadyhand Investment Funds) Some argue for outright ban on embedded trailing commissions (FAIR Canada) 7

9 ETF Industry Trends Actively Managed ETFs Actively managed ETFs expected to be fastest growing segment of the ETF industry over the next 5-10 years McKinsey & Co. expects $500 billion AUM in actively managed ETFs by 2020, and some believe much higher Recent paper by SEI Investments predicts actively managed ETFs will ultimately compete with traditional active mutual funds for market share 8

10 ETF Transparency Daily disclosure of portfolio details mandated by SEC Designated brokers (authorized participants) need to know portfolio details for hedging and arbitrage, to ensure tight spreads Not an issue for passive ETFs underlying index contents are known For actively managed fund, disclosure of portfolio exposes fund to risks of free riding and front running 9

11 ETF Transparency (cont d) Some US fund managers have applied to SEC to allow ETFs without daily disclosure of portfolio details: BlackRock November 2011 Eaton Vance April 2013 Others simply waiting for rules to change: T. Rowe Price Vice Chairman Edward Bernard stated at recent annual meeting that the company has no immediate plans to offer active ETFs, as it would have to reveal too much about the stocks or bonds under current SEC rules, which would enable other investors to put together their own portfolio of the same companies (as reported in Baltimore Business Journal, Apr 23/13) 10

12 ETF Transparency (cont d) So far, active strategies in equity ETFs in US limited to greater use of derivatives, fundamental indices, factor indices SEC has granted relief in certain areas such as use of derivatives, but as yet has not allowed non-transparent ETFs The mutual funds that have entered the true active ETF space, have done so in the fixed income area T.Rowe Price Vice Chairman Bernard at annual meeting stated that if it launches an active ETF, it may start with a bond portfolio that would be difficult for other investors to duplicate on their own 11

13 Some Say Cannibalization is Bigger Issue However Actively managed fixed income ETFs fast growing segment PIMCO bond ETF has lower fee than its mutual fund Mutual funds themselves say transparency is threshold issue how else to explain BlackRock and Eaton Vance applications Arguably better to cannibalize, suffer some margin erosion, than lose assets to competitors ETFs 12

14 ETF Format Better for Investors Intraday liquidity and price discovery Lower fees vs. conventional mutual fund format Better access through discount brokerage accounts to fund class with no broker trailing commission Greater fee transparency and simpler fee structure with ETFs no front-end load, DSC, or low load charges 13

15 Some Say Daily Liquidity Not Needed However Perception that more liquidity always better than less Having intraday liquidity does not mean they will necessarily be used as trading vehicles comforting even if not used often More flexibility to choose entry or exit strategy, and take advantage of potentially large intraday market moves More flexibility to manage risk, e.g. stop loss orders 14

16 ETF Format Impact on MFs and Dealers/Brokers More efficient format for mutual funds to administer CDS vs FundSERV Better posted fund returns (in addition to lower fees) because with ETFs the MF does not incur trading costs More efficient for brokers to execute bulk orders across multiple accounts vs. separate orders for units through FundSERV However, mutual funds may see some fee erosion, brokers/dealers may lose trailing commissions, and MF dealers cannot sell ETFs 15

17 Canadian Rules on Transparency Unlike in the US, actively managed ETFs in Canada are not required to disclose holdings daily There are a few actively managed ETFs in Canada portfolio is disclosed to designated brokers, but not to public OSC is concerned about this disparity In Canada the problem is a practical one how to enable efficient markets in actively managed ETFs if designated brokers do not know portfolio details daily 16

18 Systems for Non-Transparent Actively Managed ETFs Proprietary systems have been developed, including Robson Avoid need for daily disclosure of portfolio contents Other features/benefits of ETFs are still present: intraday liquidity intraday price discovery creations and redemptions in-kind Still enable efficient market pricing hedging and arbitrage 17

19 Why Canadian MFs Have Not Yet Launched ETFs ETF growth accelerating in past few years (AUM tripled since end 2008) MFs now taking notice Mutual funds have enjoyed high margins Symbiotic relationship with dealers and brokers re fees MFs only now starting to see asset drain to ETFs hurting profitability MFs now coming to recognize that ETFs are here to stay and pose serious threat 18

20 Market Potential Major Canadian mutual funds are closely examining ETFs At March 31, 2013 mutual fund assets reached $901 billion, roughly 60% ($500 billion) invested in equities On the assumption that 40%, or roughly $200 billion invested in large capitalization, high liquidity Canadian equities, the most applicable target for initial adoption non-transparent ETF system Market potential even higher when balanced funds are included Significant growth potential vs. current ETF AUM of $59.5 billion 19

21 The Revolution Market for passive ETFs becoming saturated Future ETF growth likely to come from actively managed Transparency is key stumbling block for actively managed equity In Canada, problem is practical one, not regulatory Significant potential, could revolutionize the ETF and MF industries 20