A Tailwind for ETF Growth in Canada

A Tailwind for ETF Growth in Canada

In the world of exchange-traded funds (ETFs), Canada is known for its history of firsts.

The first successful ETF was launched on the Toronto Stock Exchange in 1990. Called the Toronto 35 Index Participation Units (TIPs 35), the instrument tracked the TSE-35 Index and allowed investors to participate in the performance of the index without having to buy individual shares in each company. As the funds grew in popularity, Canada was later the first market to begin using actively managed products that do not disclose daily holdings.

Despite the head start, Canada saw only moderate ETF growth in the next two decades. That lag has started to recede recently due to an increasingly favorable regulatory environment, more distribution options and the draw of lower fees. The surge of global managers entering Canada's market with innovative ideas and products that work for both mutual funds and ETF wrappers is further helping to boost growth.

According to Cerulli Research, ETF assets under management in Canada grew by nearly nine percent and net new flows expanded by 19.1 percent in 2018.1

So will the upward momentum continue? Our experts highlight three trends helping to propel growth.

Ongoing Regulatory Support

Since the early days of ETFs, regulators in Canada have been known for their openness to working with managers to introduce innovative exchange-traded products while keeping the end investor top of mind.

One of the advantages is that fund managers in Canada are not required to reveal daily fund holdings, a disclosure requirement that many believe may have been holding managers back from entering the ETF space in the US and other global markets. In 2012, the Canadian Securities Administrators (CSA) began to further modernize rules and regulations to respond to the evolving investment landscape. Recognizing the growing role of ETFs, CSA sought to streamline market access by eliminating the need to apply for regulatory exemptions, a cost and time-to-market savings for both managers and end investors.

Since the early days of ETFs, regulators in Canada have been known for their openness to working with managers to introduce innovative exchange-traded products while keeping the end investor top of mind.

1 Cerulli Associates, U.S. Exchange-Traded Fund Markets 2018: Innovating for the Investor, January 16, 2019. 2

But regulation surrounding the Client Relationship Model -- Phase 2 (CRM2) is what electrified the market in Canada. Introduced by CSA, this mandate was developed to create greater transparency for investors by giving them a clear look at their account performance and what they're paying to achieve that performance. Since its adoption in 2015, flows to ETFs have trended 50 percent higher than flows to mutual funds.2

An Innovation Edge

The openness to new product ideas by both regulators and managers has long been recognized as a driving force behind the flurry of innovation in Canada's ETF market.

Actively managed ETFs are a great example. Because there are no daily disclosure requirements, active managers feel more comfortable bringing their best ideas to market without concerns of having to reveal their full strategy. While managers do have an obligation to disclose top holdings and to share fact sheets with their investors, they do not have to reveal the full basket or holdings. Investors have the transparency they need to understand performance, fund strategy and costs, while managers are able to protect their intellectual property.

The advantages of active ETFs, which include cheaper alpha and broader distribution, have already started to emerge in Canada. ETF flows to active investments surpassed passive funds in 2019, and assets to active investments have been steadily increasing since 2015.3

Another innovative approach in Canada is the ability to add an ETF series to an existing legacy mutual fund. This can increase speed to market at scale by using the same legal structure and single pool of assets as a mutual fund. Additionally, this approach does not require the complete ETF infrastructure that typically accompanies a standalone physical ETF that processes primary market activity in kind. As ETFs are not required to disclose holdings daily, using the ETF series approach allows managers to invest in both passive and active strategies. The benefit for the end investor is that they have a choice of a single strategy using both a traditional mutual fund and ETF wrapper that trades intraday on an exchange.

While the market is still highly concentrated among larger distributors, smaller managers see a growing opportunity.

The growing interest in Canada's ETF market runs the gamut from global managers entering Canada for the first time to local managers entering the ETF space for side-by-side use of ETFs and mutual funds.

2 ETFGI Canada ETF Insights 03/31/19. 3 ETFGI Canadian ETF Insights as of 07/31/19, 2019 flows annualized.

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The openness to new product ideas by both regulators and managers has long been recognized as a driving force behind the flurry of innovation in Canada's ETF market.

Thematic Investing and Asset Allocations For managers looking to hone in on a potential market opportunity, thematic investments have helped them to identify and invest in macro-level trends. It's an investment strategy that appeals to a broad range of investors. Investors may also find that they have access to products not available in other domiciles. Cannabis investment products were first to launch in Canada, for example.

Certain products, such as digital currencies and blockchain products, may appeal to a younger generation of investors who can afford to take on more risk and uncertainty in their investments.

For those closer to retirement age, a mixed asset allocation strategy allows investment in an ETF that covers fixed income, cash and equities all in one product. Thematic investing has also opened opportunities for asset managers to create unique products for their end investors.

How We Can Help

At State Street, our purpose is to create better outcomes for our clients and the people they serve. As the largest provider of ETF servicing to the Canadian market, with 80 percent of ETF assets under management,4 we use our knowledge, scale and global footprint to our clients' advantage. Our follow-the-sun global operating model allows us to meet our clients' needs wherever they do business. By building strong relationships, we're able to understand the nuances and challenges they face and embed our teams directly into their daily operations.

No matter the client's size, our focus on technology, experienced staff, consultancy services and thought leadership means we're able to help at every stage of building an ETF portfolio. Whether launching their first fund or adding to a portfolio of existing products, we help clients confidently connect to the ETF marketplace.

4 As of October 31, 2019 4

For more information, contact:

FRANK KOUDELKA

Senior Vice President +1 617 639 2006 francis.koudelka@

ROBYN THOMPSON

Managing Director +1 647 775 5707 rthompson5@

JEFFREY SARDINHA

Vice President +1 617 866 7283 jsardinha@

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