On the Money with Dynamic Funds

PARTICIPANTS

Peter Tomiuk
Vice President of ETF Distribution, Dynamic Funds

Alan Green
Vice President and Head of ETFs, Dynamic Funds

Announcer: You're listening to the ETF Exchange, presented by On the Money with Dynamic Funds. Join us as we dive into the latest trends and investment strategies to help you navigate the ever-evolving landscape of ETFs.

Welcome to ETF Exchange, presented by On the Money with Dynamic Funds. This series will explore the world of exchange-traded funds, where we break down complex financial concepts into easy-to-understand discussions. Join us as we dive into the latest trends and investment strategies to help you navigate the ever-evolving landscape of ETFs. Whether you're a seasoned investor or just getting started, our goal is to provide valuable insights to help you make informed decisions and grow your wealth. Subscribe now for a deep dive into the exciting world of ETFs.

Alan Green: Hello, everyone, and welcome to another edition of the ETF Exchange. I'm your co-host, Alan Green.

Peter Tomiuk: And I'm your other co-host, Peter Tomiuk. It's great to be here today.

Alan: Now, today's podcast is all about flows and what's been going on in the world of ETFs. This is something we do every six months or so, and we're now a little bit past the halfway point of this calendar year. Sadly, the summer months are coming to an end, and I'm sure the end of the year will be here sooner than we think. Now, 2024 has so far been on for the record books of the ETF world. We've seen record asset flows and a record in terms of new product that's been launched. To me, the growth of ETFs shows no signs of stopping, so let's get into it.

First question I have for you, Peter, I don't think 2024 could be any different than 2023 when I look at the amount of inflows and where they're going. Peter, can you just walk us through what you've seen so far?

Peter: Absolutely, Alan. We could not have done more of a 180 in 2024 versus what we did in both 2023 and 2022, so let's rewind the clocks a little bit here. 2021, we saw record flows in the ETF industry, much of that having to do with the phenomenally strong markets we saw after the COVID crash in the spring of 2020. Now, I think we all remember 2022 as being a very difficult year where both equity markets and fixed-income markets fell substantially. The major themes of that year were the war in Ukraine, rampant inflation, and central banks raising rates to combat that. Now, this really created an environment that we had not seen in a long time. As a result, ETF flows fell dramatically from 53 billion the prior year to 35 billion.

Now, a few things to keep in mind. ETF flows fell, but they were still very strong, showing both the resilience and the popularity of ETFs as a whole. They were dominated by cash and conservative fixed income, the latter being extremely enticing as cash ETFs were providing 4% or even 5% yields. Not a bad payout for those trying to take risk and volatility out of their investments. Now, in 2023, it was actually a very strong year for equities, but it wasn't really confirmed by ETF flows. There were still lots of investors on the sidelines, there was still lots of money going into cash and conservative fixed income, even though indexes like the S&P 500 had bottomed out in the autumn of 2022.

Now, that being said, by November or so, there was almost a feeling of FOMO, a fear of missing out on that equity rally. Since then, we have seen flows really accelerate throughout 2024. Now, there are a few interesting points that I want to mention. After two years of being in the doldrums, equity flows are crushing it. I believe they will have record flows this year. A big reason is that investors are not just investing in low-cost index ETFs like the SPYs or the XIUs. They're investing in solutions that are non-passive with a little more breadth, and we can discuss that a little later, Alan.

Another thing, cash is no longer king. We have seen steady outflows in that asset class. Lastly, even though equity is outpacing fixed income, this is not a testament to bond ETFs losing their appeal. On the contrary, in our current rate environment, bond ETFs have been extremely appealing on various parts of the curve, so there's plenty of flow there. If you put that all together, it's setting us up for a tremendous year. In my opinion, the Canadian ETF industry will surpass 2021's record of 53 billion of inflows in this calendar year.

Alan, another area that's been growing consistently at about double the speed of the overall ETF industry are multi-asset ETFs. I know this is an area that you've put a lot of work into and find to be a very nice solution for a large cohort of investors. Can you walk us through what they are and why they have such an appeal?

Alan: For sure, Peter. I think we've touched on these guys before, but I think it's worth going over really the basics of what are multi-asset ETF's and then we can talk a little bit about what choice they are and why we think they're primed for more growth. Multi-asset ETFs can be defined as an ETF that holds other ETFs. Now, typically, when you look at an ETF, an ETF buys a bunch of stocks or bonds or whatever directly. That's a little different to a multi-asset ETF. Now, multi-asset ETF don't buy those stocks or bonds directly, instead they buy a bunch of other ETFs.

Now, to me, the big advantage here is that that single ETF provides a super-diversified portfolio in one simple-to-purchase product. They also work great for folks that really don't want to go out there and sort of build their own portfolio, pick and choose their own ETFs. Now, typically, multi-asset ETFs are professionally managed by a portfolio manager who does all of that due diligence for you. They sift through all the ETFs and come up with a portfolio that's in line with the investment objective of that ETF. Now, to me, that's super helpful, and a big time saver for investors who don't want to sift through, what is it now, 1,400 or so ETFs that are out there and build their own portfolio. I also want to mention that these portfolios of ETFs can also be purchased through mutual fund wrappers, and that's great for investors that prefer that investment vehicle.

Now, when it comes to different types of multi-asset ETFs, there's a vast array of solutions and each with their own sort of value proposition. Now, I bucket them in three different categories. First up is risk tolerance. There's a bunch of different multi-asset ETFs depending on what you want to do, things like growth, the balance conservative. They're kind of risk-aligned to what the outcome the investor is looking for. Management style is another way we look at them. We know that there are active solutions here that very much aligns to our firm, but there's also passive and sort of a mix of both within these solutions.

Lastly, income. I think we're going to talk a little bit about income later in the pod, a very popular choice at the moment for investors. Again, you can find multi-asset ETFs with a focus on providing income. Now, I definitely see more potential types of ETFs in the future, specifically in the direct investing space. I think there's a lot more growth to come. They're simple and a very effective product. It seems like active ETFs are getting more traction. I think we almost see daily headlines about how big the market's going to be. Even massive passive asset managers are talking about active ETFs, which is quite surprising. I'd love you to talk a little bit about the trend and maybe what's driving that growth that everyone's getting excited about.

Peter: Let me start with a few numbers. A recent publication by Investor Economics showed the breakdown of ETF assets in Canada, and there's no doubt that actively managed ETFs have been becoming a larger percentage of total assets. At the end of 2021, they represented about 24% of total assets, and now we're at 30%. That's a very large increase in a very short period of time, especially when you take into consideration the rapid growth of the ETF industry as a whole. Also, when looking south of the border, actively managed ETFs have also picked up steam, now representing close to 30% of new flows. I even heard rumors that the well-known multi-billionaire hedge fund manager Bill Ackman might be considering an ETF of his own, so we'll see what happens there.

All of this to say, there has been an upward trend in the adoption of active ETFs, and I believe there are three main reasons for this. Number one, the PTSD many feel from the fixed income pain we have gone through in the era after the COVID crash. I think investors are showing that they have no issue paying a little more for active management here if it means having the proper tools to mitigate volatility in that space. Number two, the high concentration in individual names in major equity indexes and a desire to broaden out exposure and capitalize on other opportunities.

I think we all know that names like Apple, NVIDIA, Microsoft, and other mega-cap tech names that represent what is commonly known as the Magnificent Seven represent a large portion of major indexes like the S&P 500. There is no doubt that these are strong companies, but they are subject to volatility like other stocks out there. Diversification is so important, and it seems to me that active ETFs are being used as solutions to get that breadth at levels that we've never seen before.

Lastly, an aging demographic that requires different needs like income generation and risk mitigation. Indexes will not provide you the income or the risk mitigation that these investors require, so active ETFs are being used more and more solutions to provide for this. Alan, speaking of income, everyone loves receiving a periodic paycheck. I know I certainly do. There are a lot of ETFs out there that are generating monthly income through covered call or covered option solutions and it seems that every year record flows are entering that space and record amounts of these types of ETFs are being created as well. Can you talk to us about that? Are they a fad, or are they here to stay?

Alan: That's a great question, Peter. To me, I think ETFs with option strategies within the portfolio are definitely a long-term industry trend. I don't think they're a fad. I think this is something that's going to be here for a good while. Now, a bit of history. Options ETFs have existed in the Canadian ETF industry around 50 years, and they've grown to around just over 25 billion in AUM in these types of strategies, which is pretty substantial given the overall market. As you point out, it keeps growing at a record pace.

Now, a little bit like ETFs overall, I think the growth of options-based ETFs is driven by the strength of those strategies lining up with a lot of investors' needs. A lot of those investors' needs now link to where they are in their stage of life, which is approaching or actually having retired. A few things come to mind in that stage of life. One, investors seem to like the income that can be generated by selling options. Now, that's super important, especially with inflation rate being so high. Generating enough income to beat inflation is a challenge and these products can be one tool in the toolbox to help investors do that.

Secondly, investors are willing to give up a little bit of the upside in their investment if there's that income on offer and that income is consistent and stable. Lastly, some of those options ETFs out there have some form of downside protection to try and limit losses if the market falls substantially. I'd also say, over the years, there's a lot more education available to investors and that's helped with the sophistication level around options and the growth. A couple of notes of caution though for our listeners. ETFs that use options and general derivatives can get a little complex. It's super important to understand how they were, the pros and cons of owning these in your portfolios.

Also, when some of these adverts about incredibly high yields, you see a lot of these big numbers thrown around. It's worth doing your homework, digging into it, asking the issuers how much of that yield is sustainable and being driven by the portfolio rather than just turning around to hand you back your own money as a distribution. Again, just watch for those type of things and then do your homework. That being said, I do believe these types of strategies will continue to attract a lot of attention again just with that demographics and the appeal.

Getting towards the end of this pod, Peter, let's put you on the spot. Any bold predictions for the rest of the year? Maybe some areas that you haven't spoken about so far and that may be of interest in the weeks and months to come as we run into the end of the year.

Peter: Well, Alan, look, I've certainly been known to have a bold prediction or two, but I must absolutely warn listeners that there is definitely no crystal ball here when it comes to this kind of stuff. That's my disclaimer for this podcast. As we all know, ETF flows can be very trend-sensitive and can turn on a dime rather quickly. I mentioned earlier how for two years, cash was king and equity was in the doldrums, and then within a few weeks, that trend completely reversed itself and we seem to still find ourselves in that environment now.

Now, for the last few years, we've grown accustomed to fearing a rising rate environment. The more and more I see what's happening in the market, I think investors are going to have to start thinking of declining rates and what that means for their investments and for opportunities going forward. Now, the Bank of Canada recently dropped their rates. Chairman Powell in the U.S. seems to be sending signals of dropping rates and the market is certainly reacting to that. We've seen bond yields fall substantially over the last few weeks.

My bold prediction is that you will see ETF flows now enter spaces that either got depleted during a rising rate environment, making them very enticing from a value and opportunity standpoint, and/or ETF flows entering spaces that just tend to do well when rates fall. Fixed income-wise, I believe we will see good flow in conservative fixed-income ETFs with a little more duration to profit off a decline in rates and a normalization in the yield curve, so investment grade bonds with not too long, but not too short duration either. I see that as being key.

On the equity side, I think gold equity ETFs will garner a tremendous amount of interest. Gold keeps on hitting new highs, Alan, and the profit margin on gold companies should follow suit. Add to that fears of a recession, government debt levels. All this makes that a rather interesting opportunity. Also depleted areas like REITs that are backed by hard assets and pay a substantial yield, they should get a lot of attention in this kind of environment as well.

The beauty of those two areas is that when you look at large indexes like the S&P 500 and the TSX, these sectors tend to be very underrepresented, meaning that these types of ETF solutions are a fantastic way for investors to get the exposure they need in these spaces. That's actually consistent with a broader trend that we're seeing where investors are showing a desire to broaden out their equity exposure into different spaces that make a lot of sense. Alan, that's my bold prediction for you.

Alan: Thanks, Peter. I just had one more actually, which is private equity and private debt. A lot of headlines coming out in the past few weeks about ETFs and if they're going to make a move into that market. I think you and I both know sort of the struggles between a private market and ETF. That's one that I'm going to definitely watch into the year of the end because that's a huge market. With that, I think we'll conclude this podcast. I definitely look forward to reviewing those predictions and stuff you made. I wish our listeners a great rest of the summer and look forward to speaking to you again soon on the next episode. Thanks, everybody.

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