ETFs and mutual funds will co-exist for some time yet

ETFs and mutual funds will co-exist for some time yet

It’s not an either/or issue between ETFs and mutual funds.


MONY01_FEBMAR2014-FB_edited-1The February/March 2014 issue of MoneySense has just been produced and is due to hit subscriber mailboxes and newsstands shortly.

February/March is always our annual RRSP issue and until a year ago, that issue featured Suzane Abboud‘s Best Mutual Funds. Suzane used to write a regular mutual fund column for us throughout the year but decided to take a break from it. She is however back for the annual mutual fund roundup.

A year ago, we introduced the MoneySense ETF All-Stars, written by Dan Bortolotti with the assistance of a small panel of ETF experts. Dan also writes the popular Index Investor column and authored the MoneySense Guide to the Perfect Portfolio. He’s back with the second edition of the ETF All-stars, a feature we plan to revisit at this time every year.

However, as was the case last year, we did not jettison the mutual fund package to make way for ETFs. Instead, we opted to align the mutual fund package with a philosophy Suzane had espoused in one of her last regular columns. Given the very low payouts on most bonds, and the relatively higher MERs charged by most bond mutual funds (compared to bond ETFs), she felt it made more sense to focus on those mutual funds that at least had a good shot at beating the indexes and justifying their slightly higher MERs: that is, stock or equity mutual funds. So we no longer look at bond mutual funds or even balanced mutual funds, because the latter normally sport an equity-like MER even if they’re 40 or 50% invested in fixed income.

So in Suzane’s 2014 mutual fund feature, she simply advises readers to buy bonds directly or to buy fixed-income ETFs for the fixed-income portion of portfolios. Incidentally, MoneySense‘s fixed-income columnist, Pat Bolland, also wrote a primer on how to buy bonds or GICs directly.

Lines between mutual funds and ETFs keep blurring

I’ve written before in the magazine that in some ways, the ETF and mutual fund industries are converging. Certainly we see more and more “slicing and dicing” of the ETF industry, as the industry drills down on ever tinier niches, whether of economic sectors or geographical regions. A good example of super-specialized ETFs are the Global X family, which offers a number of sector ETFs focused solely on China.

Cynics might say these newer specialized ETFs tend to carry higher fees and that the industry may be picking up the bad habits of the mutual fund industry, which generally introduces new products whenever it spots a hot new trend that naive investors would be willing to throw money at.

Not that those bad habits have hurt the mutual fund industry. It’s been observed that the Canadian mutual fund industry should reach the magic $1 trillion mark in assets some time this month: unless of course the recent correction in stocks reverses the trend. One reason for the continued popularity of mutual funds is the comfort some investors find in so-called “active” security selection, which tends to be accompanied by the “advice” preferred by the salesperson who supplies funds to retail investors.

It’s not even just about trailer commissions

The aforementioned cynic would add that the “trailer commissions” designed to induce a fund salesperson to keep clients “fully invested” are a big reason for the continued popularity of mutual funds. Gradually, though, we’ll see ETFs adopt this tactic. Before it was acquired by BlackRock Canada’s iShares, Claymore had a series of “Advisor Class” ETFs that also paid advisers trailer commissions. And any fee-based adviser that recommends some combination of ETFs or other investments will typically charge an asset-based fee somewhere near 1% a year, which accomplishes much the same thing as a direct trailer fee. These may include actively managed “F class” equity mutual funds with the nominal trailer stripped out.

And that’s perfectly fine. As Suzane points out in her feature, there are a handful of actively managed mutual funds that really ARE worth owning. Senior Editor David Hodges made similar points last year when he wrote an article headlined “Mutual Funds Rediscovered.” Their point is that you want to avoid so-called “index hugging” mutual funds that look just like index funds but that charge the MER premium normally associated with true active management.

You can’t even declare that all mutual funds are actively managed and that all ETFs are passive index-tracking vehicles. For one, all the big bank no-load mutual fund complexes have long offered index mutual funds. TD’s e-Series funds always do well in MoneySense articles, as one of the Portfolio Makeovers contained in the new issue make clear (also written by David Hodges).

RBC Quant Dividend Leaders bring something new to  equity ETFs

It’s not even true that all ETFs must be index-tracking investment vehicles, even though that remains the biggest focus. A case in point is the recent launch by RBC Global Asset Management Inc. of three new actively managed equity ETFs known as the RBC Quant Dividend Leaders ETFs. This in itself was newsworthy because it marked RBC’s entry into equity ETFs. Until the Jan. 15 announcement, RBC ETFs were exclusively corporate bond ETFs, known as the RBC Target Maturity Corporate Bond ETFs, originally announced in September 2011. Incidentally, fees on those funds have also been reduced.

Relative to the ETF competition, all of which have strong index equity ETFs, RBC was late to the equity ETF party so it had to do something different. This it has done by eschewing passive management and embracing a form of active security selection, but with management fees comparable to indexed ETFs. Technically, it uses a “rules-based” set of screens to identify income-paying securities that meet certain value criteria, as explained here.

Note the focus on giving investors regular monthly income. The RBC Quant Canadian Dividend Leaders ETF (ticker RCD/TSX) and RBC Quant U.S. Dividend ETFs (RUD/TSX) sport fees of just 0.39%. In addition it filled a niche not before present in the Canadian market with the RBC Quant EAFE Dividend Leaders ETF, with a fee of 0.49%. (MERs will be slightly higher once the ETFs have a full year under their belts). Each come in versions denominated either in CDN$ or the US$.

Seek dual-or triple-licensed advisers

In short, whether you’re an individual investor or an adviser, it’s not an either/or issue between ETFs and mutual funds. I own both in my own portfolio, along with individual securities, and I’d guess most seasoned investors do as well. But if the industries do end up co-existing, investors will be best served by using investment advisers who are qualified to sell both mutual funds (i.e. through the MFDA channel), as well as securities like ETFs and individual stocks and bonds: that is, via the IIROC channel. And so much the better if they’re also qualified to recommend insurance solutions: the new issue also introduces a new insurance column by industry veteran and CFP James Daw. It’s called Insurance Uncovered.