It used to take a minimum of $7.5-billion to have Bridgewater Associates take your business. But pretty soon, any schmuck with a trading app will be able to toss a few bucks at the world’s largest hedge fund.
Bridgewater has started the process of bringing its famously guarded investment approach to an exchange-traded fund. ETF provider State Street will create the fund, and Bridgewater will provide a model portfolio for the fund to track.
Such is the power of ETFs to open doors to some of the most exclusive quarters of the financial markets and give everyday investors a seat at the table.
Forget for a minute that Bridgewater has badly trailed the stock market in recent years, as it drifts ever further from its heyday of the 2000s when it amassed obscene fortunes. The mere fact that it is jumping on the ETF bandwagon is a sign of the times.
An ETF is basically a mutual fund that trades on a stock exchange. This simple little financial shell has proven to be the most disruptive force in asset management of the past quarter century. We can thank the ETF for busting the mutual-fund monopoly, for ushering in the low-cost passive investing movement and for democratizing the investment landscape.
Now, it seems like ETFs are where all the action is. There hadn’t been a single corporate initial public offering on the Toronto Stock Exchange in more than 20 months, until fast-fashion retailer Groupe Dynamite Inc. broke the drought two weeks ago. But nearly 200 ETFs have launched on the exchange over that time.
And in every region of the world, record amounts of money have flowed into ETFs this year, with a month to spare. There was US$14.4-trillion of assets invested in them globally at the end of October, which is more than triple the size of the hedge fund industry, according to ETFGI, an independent research and consulting firm.
Here is a closer look at some of the ways the ETF boom is upending the industry.
Canada comes around to its own invention
Despite Americans laying claim to the birthplace of the ETF, that title belongs to Canada.
The idea was simple: a basket of assets, like a mutual fund, that trades continuously on the stock market. That way, institutional investors could move large amounts of money in and out of the market on a whim.
In 1990, the world’s first ETF began trading on the TSX, called the Toronto 35 Index Participation Fund, or “TIPs.” It still trades today as the iShares S&P/TSX 60 index ETF.
This was the prototype that would eventually come to redefine investing for much of the world.
But not without a fight from the industry’s incumbents. The mutual-fund lobby successfully thwarted the introduction of ETFs in the U.S. for more than three years.
Looking back now, the industry’s powers were right to fear ETFs. But it took the global financial crisis to bring the competitive threat to the fore.
“That was when the U.S. investor base realized, ‘If I’m going to be paying 2 per cent to professional managers, and I’m still exposed to a 50-per-cent downside risk, I might as well cut my costs to the bone,’” said Daniel Straus, managing director of ETFs for National Bank Financial.
Many disillusioned investors landed in ETFs that passively track the market. ETFs have been stealing market share from mutual funds in the U.S. ever since.
The shift was slower to take shape in Canada, where loyalty to mutual funds was much more entrenched. This is partly due to the dominance of the big banks and fund companies over asset management in Canada. Most of the big Canadian banks still don’t allow their branch-based advisers to sell clients ETFs. Instead, the incentives are heavily skewed toward mutual funds, which typically carry much higher fees.
The pandemic appears to be the catalyzing crisis for Canadian ETFs, Mr. Straus said. Over the last three calendar years, up to the end of October, ETFs have seen net inflows of roughly $130-billion, while more than $90-billion has flowed out of mutual funds.
The paradigm shift that has its roots in Canada finally seems to be gaining traction here.
A better mousetrap
Today, pretty much anyone can own the entire stock market for close to no cost. Fees on broad-based equity ETFs are miniscule, while trading commissions are quickly vanishing.
For not much more, you can buy a globally diversified portfolio of stocks and bonds in what are called asset allocation ETFs. They even rebalance on their own.
For many regular investors, here is a complete investment plan in a single ticker with a management expense ratio, or MER, as low as 0.2 per cent. In a country long dominated by underperforming mutual funds with exorbitant fees, this is practically revolutionary.
“I think ETFs have done more for the average investor over the last 20 years than anything else, to be honest,” said Sal D’Angelo, head of product at Vanguard Canada.
ETFs and indexing have spawned a sort of populist evolution. Fees have steadily declined across the investing universe, saving investors trillions of dollars cumulatively. Mutual funds have been forced to cut fees in order to compete.
Over the past 10 years in Canada, the average MER on Canadian mutual funds has declined to 1.47 per cent from 2.03 per cent on an asset-weighted basis, according to Investor Economics.
There’s an ETF for that
The investment industry is furiously spinning off new products that test the limits of what can be stuffed in an ETF wrapper.
What started with plain-vanilla stock funds tracking the S&P 500 or the TSX soon morphed into thematic and sector ETFs. Eventually, the ETF became the instrument through which investors chased the latest fad, from cannabis to ESG to crypto-assets. The pandemic saw a flurry of ETF launches playing off themes such as digital health care and mRNA technologies.
There are now more than 1,000 ETFs trading on the TSX, compared with around 700 stocks.
One of the flavours of the year has been single-stock ETFs, which use borrowed money on top of investor funds to boost the returns of a single stock. For a product designed to combine a multitude of stocks in a single package, this is an odd, if not perverse, turn.
But single-stock ETFs have become so popular that that exchanges are at risk of running out of tickers for them, Bloomberg recently reported.
Another recent class of hybrid funds packages up options contracts in ETFs under names such as “covered call” or “buffered ETFs.” They’re complex instruments meant to protect against market selloffs while paying juicy yields. But they are dangerous in the wrong hands and can backfire on regular investors who lack a full understanding of technical risks involved.
In the ETF space, it’s not all low fees and doing right by the little guy: “There are a lot of options that probably aren’t the best for investors,” Mr. D’Angelo said, noting that there are more than 500 ETFs in Canada with less than $50-million in assets.
The next frontier in ETFs appears to be private assets. BlackRock and State Street, among other industry giants, are exploring ways of packaging investments in unlisted assets, such as real estate and infrastructure, in the ETF format. In September, private equity giant Apollo Global Management and State Street filed to launch a first-of-its kind ETF that invests directly in private debt assets.
The obvious contradiction is that private assets are illiquid by definition, while ETFs are the exact opposite: “The concept is a little at war with itself,” Mr. Straus said.
That kind of thing hasn’t stopped the industry so far. So, it’s a safe bet that private market ETFs will be coming to an exchange near you someday soon.