There are many reasons why relatively few Canadian investors use ETFs compared with actively managed mutual funds. There’s about $900 billion in mutual funds in this country, while ETF assets total about $60 billion—just over 6% of the total. One of the main reasons for that yawning gap is that most advisors in Canada are licensed to sell mutual funds, but not ETFs. But that may be about to change.
The Canadian ETF Association (CETFA), an industry group that represents the country’s ETF providers, is spearheading an effort to enable mutual fund advisors to offer ETFs to their clients ETFs.
Here’s the crux of the issue. Investment advisors in Canada can be licensed by either the Mutual Fund Dealers Association (MFDA) or the Investment Industry Regulatory Organization of Canada (IIROC). MFDA advisors—many of whom work at bank branches and firms such as Investors Group—can sell mutual funds and nothing else. Only those who are IIROC-licensed can recommend and sell individual stocks or ETFs. Up-to-date numbers are hard to come by, but a 2012 report from Advocis suggests MFDA advisors outnumber their IIROC counterparts by about four to one.
This regulatory regime made sense when there was a clear distinction between mutual fund advisors and stockbrokers. But the emergence of ETFs makes it harder to defend. Why should an MFDA advisor be allowed to recommend the TD Canadian Index Fund, but not the BMO S&P/TSX Capped Canadian ETF (ZCN), even though both have virtually identical holdings?
Overcoming the hurdles
Pat Dunwoody, executive director of CEFTA, has been leading this effort along with Sandra Kegie, her counterpart at the Federation of Mutual Fund Dealers, which represents the fund industry. Together they drew up a list of about a dozen hurdles that must be overcome before MFDA advisors would be able to offer ETFs. “Then we said let’s work through them one by one, because we didn’t see anything on the list that was impossible,” Dunwoody says.
The regulatory hurdles themselves are relatively low: everyone seems to agree that ETFs qualify as mutual funds according to the definition in securities law. The real obstacles are logistical. For starters, MFDA advisors who want to sell ETFs would have to move to a fee-based model rather than working on commission. Then there’s the question of how the TSX would accept the orders. Would they get filled with end-of-day pricing like mutual funds? How would the dealers collect the information for their clients’ annual tax slips? Dunwoody says none of these issues is a deal-breaker by itself, but it will take time for all of them to be resolved. “If we could get something in place for 2015, that would be great.”
Does everyone win?
A lot of people in the financial services industry have something to gain if mutual fund advisors can someday sell ETFs. Clearly the ETF providers want more advisors to recommend their products. TMX Group—which operates the Toronto Stock Exchange and is an affiliate member of CETFA—would profit from more trading volume. And of course, the MFDA licensees themselves would be able to offer superior, lower-cost products, which should help them gather more assets.
But not everybody will jump for joy if the change comes to pass. Some IIROC-licensed advisors will see it as an invasion of their territory. They enjoy a gatekeeper role now, since they can offer clients something their competitors cannot. Many investors have dumped their MFDA advisor in favour of one who can put ETFs in their portfolio, and those defections would become more rare if the rules changed.
Personally, I’m not concerned about the IIROC advisors: if the only value they can add is access to ETFs, that’s not very inspiring. But I am worried that advisors who grew up in the commission-based mutual fund culture still don’t get ETFs. To give a typical example, I recently received an email from a reader whose advisor told him the Global Couch Potato is poorly diversified because it contains only three funds—he apparently had no clue these three funds contain over 750 bonds and almost 2,000 stocks in more than 20 countries. The advisor also warned the reader that if ETFs get too popular, they will become “overbought” and their prices will be distorted. This guy should not be allowed within a hundred metres of an ETF unless he is thoroughly educated about how they work.
I also worry that expanding an advisor’s product line isn’t likely to change his investment strategy. As I’ve argued before, mutual funds are not inherently inferior to ETFs: the problem is that high-cost active management is inferior to low-cost indexing. MFDA advisors may be able to bring ETFs to more Canadians, but if they continue chasing performance or using sector funds to make tactical plays, their clients won’t be any better off than they were before.
Despite these concerns, though, I think the change would be a positive one for Canadian investors. One of the indirect benefits may turn out to be the most significant: it should encourage more commission-based advisors to move to a transparent fee-based model. Access to better products is fine, but meaningful change will only come when the financial industry finally separates products from advice.