Would Canadian pension funds use ETF strategists?

Why they might have trouble gaining a foothold.

July 3, 2014

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peanut butter cup_edited-1Although exchange-traded funds (ETFs) have evolved into a market phenomenon over the last decade, they’re still just drops in the great big bucket of global asset management, especially compared to mutual funds. According to this graphic on the history of ETFs, total ETF assets globally stand at US$2.3 trillion while total mutual fund assets worldwide are US$30.05 trillion (Investment Company Institute).

Clearly, ETFs have a long way to travel before they become serious rivals to the behemoth that is the global mutual fund industry.

Which is where ETF strategists could possibly come in.

ETF strategists manage investment strategies made up of ETFs, combining active and passive management into a whole new package for investors. Think of it as the Reese’s Peanut Butter Cup of the investment industry (remember that old commercial where a chocolate lover and a peanut butter fan collide and invent a whole new salty-sweet combo?).

According to Morningstar, U.S. assets in ETF model portfolios sold by ETF strategists grew by 40% in 2013, up to just under US$100 billion. The year before, the growth rate was 50%. Clearly, they’re a big hit south of the border, and, as Morningstar notes, that kind of growth shows ETF strategists are now an engine of ETF growth.

Here in Canada, iShares has been tracking the rise of ETF strategists—growth has been more modest, but the trend is similarly positive. Its ETF strategist program has expanded to more than $4 billion in ETF assets as of December 2013. Note that programs tracked by iShares hold approximately 75% ETFs.

But while ETF strategists might make sense for retail investors wary of building their own do-it-yourself portfolios, some have their sights set on bigger fish—institutional investors such as foundations and pension funds. As BlackRock’s Katharine Earhart told CNBC’s Nightly Business Report, “We hear from our strategist clients that they have been getting mandates from pensions.”

Does this mean ETF strategists are the next big thing for pension investors? Not necessarily—according to Fundfire, it’s been an uphill battle mainly because the moniker “ETF strategist” doesn’t necessarily fly with institutions. Firms have instead had to reposition themselves as asset managers that choose to implement their strategies with ETFs rather than putting ETFs first and foremost.

However, that kind of branding issue could extend to both the retail and institutional side where ETFs have been broadly marketed as a cheap and liquid alternative to big expensive mutual funds. As one manager noted to ETF.com, there’s no reason to think that switching from stock picking to ETF picking is going to deliver better returns.

For ETF strategists, it means a new way of talking about the product—and how it can be used.

For Canadian pension funds just beginning to consider the uses of ETFs, strategists might have an even tougher job getting a foot in the door.

But it’s worth expanding the discussion—even just to see how active mixes of ETFs can work together in a single portfolio.

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MARK.YAMADA.1

ETFs offer conveniences to retail investors and, on a more selective basis, to institutions and pension funds. Diversified access to difficult or emerging markets is one example. The tactical use of ETFs for cash equitization and transfers is well known. Less well known is the impact of combining pre-diversified portfolios of securities, in other words, how to attribute performance and measure risk for portfolios of ETFs. Research suggests that concentrated portfolios are the best way to add value over broad indices. When dealing with portfolios of ETFs, "where's the alpha?" may echo that other famous ad and new ways to measure risk may be needed.

Transcontinental Media G.P.