Exchange-Traded Funds in Canada

Adapting to succeed amid intense fee pressure

Downward fee pressure on Canadian Exchange-Traded Funds (ETFs), spurred by increasing competition and rising investor demand for lower-cost products, is intensifying the battle for market share among ETF firms.

Growing market

ETF assets under management in Canada have experienced significant growth over the past decade, increasing more than sevenfold to CAD 147 billion at the end of 2017.1

Initially focusing on passive, index-based funds, the Canadian ETF industry is now experiencing the emergence of higher margin ETFs that utilize active and strategic beta strategies. These emerging ETFs are designed to generate greater risk-adjusted returns than traditional passively managed products, while offering greater liquidity and comparatively lower fees than the mutual funds they compete with.

During the three-year period ending October 31, 2017, assets of ETFs employing strategic beta and active strategies increased by annual average rates of 26 percent and 48 percent respectively, outpacing the 21 percent annual growth achieved by the more traditional passively managed strategies.2 While active and strategic beta strategies have recently experienced faster growth than passive ETFs, the newer strategies currently represent only 29 percent of total ETF assets.3

Pressure on fees

The significant growth in total ETF assets has been counterbalanced by a steady decline in fees as the industry moves toward greater transparency. Average ETF fees dropped from 40 basis points in 2011 to 33 basis points in October 2017.

At the same time, there are wide variations in the fees charged by different ETF providers across all asset classes and strategies. This is expected to intensify fee rivalries among Canadian ETF providers, mirroring the experience in the US, where fees for certain passive strategies are nearing zero.

Increased fee pressure on passive strategies—and mutual funds—is pushing active and strategic beta strategies to also reduce their margins as a means to enhance competitiveness. The resulting shift is expected to further narrow the gap between passive funds and the newer strategies.

Industry rationalization

While fee compression benefits the end investor, reduced margins have a negative impact on the profitability of ETF providers, driving the need for improved efficiency and greater economies of scale across all providers.

At the end of 2017, three firms (including two large US firms) accounted for more than 80 percent of the total Canadian ETF industry assets of CAD 147 billion; of the remaining 25 firms, 10 had assets of CAD 100 million or less, collectively accounting for only 0.2 percent of total industry assets.4

As fees continue to decline, it is likely to become even more challenging for smaller firms to remain competitive. This could lead to rationalization of the Canadian ETF industry, where smaller providers could be absorbed by larger industry participants or merge with other players to achieve greater scale. The ETF industry may also see non-bank firms establish partnerships with independent brokers to gain shelf space.

Adapt to succeed

With fee transparency top of mind for investors, the low cost solution offered by passive ETFs points towards the strong likelihood of their continued rise in popularity. ETF providers with the financial resources and technological capability to further improve efficiency and offer lower fees, regardless of their investment management strategy, are poised to continue to seize market share.

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1Canadian ETF Association, December 31, 2017
2Strategic Insights, October 31, 2017
4Canadian ETF Association, December 31, 2017