Will Mutual Fund Advisors Soon Be Selling ETFs?

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. 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.

11 Responses to Will Mutual Fund Advisors Soon Be Selling ETFs?

  1. SV August 27, 2013 at 5:46 pm #

    Due to regulations we Canadians can not purchase US mutual funds. My hope is that one day a ETF version of ING Corporate Leaders Trust Series B (LEXCX) would be available to us.

    Currently the closest alternative I could find is the Dow index.

  2. GOTCHA August 27, 2013 at 9:47 pm #

    As long as advisor are not going to start selling XIU with a 2% fee. Keeping that 1,5%.

  3. John P August 27, 2013 at 11:52 pm #

    I can only hope that this change somehow causes severe pain for all MFDA advisors due to less opportunity to gouge their clients with exhorbitant mutual fund fees.

    Yes, I’m bitter…before discovering couch potato investing I lost large amounts of my hard-earned savings at the hands of an incompetent MFDA advisor who squandered it on over-priced, under-performing mutual funds

  4. JS August 30, 2013 at 1:58 pm #

    HI Dan,

    I recently got acquainted with this awesome blog/site through the book Millionaire Teacher. And since than I have been reading a lot of articles written by you and comments by your other followers. I am really a fan of your crispy and to the point writing.
    After reading Andrew Hallam, I am now reading Bogle’s masterpiece “commonsense investing” and I am totally sold on the idea of index investing (You know I work for a big MF investment company and have all the money invested with them as I got significant MFR discount)
    I am going over a lot of articles and understanding all the pros and cons of ETF/ US vs CDN etc. which I hope to overcome soon and will build a CORE etf portfolio.
    But I have a question for you. How should we (wife and I) treat our work pension contributions (DC plan) which goes to companies like Sunlife etc. Should we use a balanced fund(around 1% fees) their and move to the CORE portfolio LIRA once we move the job? Or should we still treat that as part of overall portfolio but then rebalanceing would be a concern. Between me and wife we have TFSAs, RRSPs and DC plans plus a unregistered accts.. To many to manage and re-balance.
    Any advice would be helpful
    Thank you
    JS

  5. Canadian Couch Potato August 30, 2013 at 2:17 pm #

    @JS: Welcome to the blog, and thanks for the kind words. The answer to your question depends a lot on the circumstances. In general, it makes sense to treat all of your own and your wife’s accounts as a single large portfolio (assuming it will all fund your retirement), and therefore you can use the most tax-efficient accounts for each asset class. For example, it might make sense for one RRSP or DB plan to be 100% bonds while one non-registered account is 100% Canadian equities. There’s not much else to say without knowing the details.
    http://canadiancouchpotato.com/2012/03/12/ask-the-spud-investing-with-multiple-accounts/
    http://canadiancouchpotato.com/2012/03/15/a-spreadsheet-to-manage-multiple-accounts/

    With DB plans, one of the problems is that your fund choices are limited, and different plans vary in quality. If you have access to lost-cost index funds in all asset classes, then you have many options. But if, for example, all the equity options are overpriced active funds, then you’re probably best off keeping the bonds there. It’s just impossible to be any more specific than that.

    These asset location decisions are hugely important, but also quite complicated. They’re a big part of our DIY service.

  6. Brian August 30, 2013 at 3:49 pm #

    In my opinion this article misses discussing the pink elephant in the room.

    What’s the point of having investment advisors licensed if they have no legal fiduciary duty to their clients? Seems to me that the MFDA and IIROC are just self serving groups that exist as a way to gain a legal monopoly over providing “investment advice” without any true responsibilities to their clients that other licensed individuals like lawyers and doctors have.

    By “licensing” them, I would suggest that most lay people assume they must have a fiduciary duty. Without that duty, I suggest that we drop all the meaningless licenses and just require that advisors clearly disclose that it’s really a caveat emptor situation.

  7. Brian August 30, 2013 at 4:05 pm #

    One other thought, if “financial advisors” don’t want to have a fiduciary duty, then in full transparency to the lay public they should drop the term advisor and their name should be changed to “financial salesperson” which more accurately reflects their current role.

  8. Steve September 18, 2013 at 5:48 pm #

    Hi Dan:

    In the first paragraph you write: ” There’s about $900 billion in mutual funds in this country, while ETF assets total about $60 billion—just over 6% of the total.”

    Can you let me know where you got your figures from? I’ve been checking Canadian ETF Association, ETF Insights, CSA and other sources but am having trouble finding these, or really any, solid up to date figures about the size of either type of investment. I’m not questioning the accuracy of what you write above. It’s more where to go to find the data – could be I’m just not looking hard enough 🙂

    Thanks!

    Steve

  9. Steve September 18, 2013 at 5:56 pm #

    I should be more specific that besides sources for these figures, I’m trying to compare the two. I found the $60 billion figure in Cdn ETF Assn’s July 9 commentary, but how does this compare with Canada’s mutual industry and what percentage of the total market for investable assets is ETF’s $60 billion? The latter of the two is where I’m having the most trouble tracking down figures.

  10. Canadian Couch Potato September 18, 2013 at 6:32 pm #

    @Steve: As you found, the Canadian ETF Association is the place to go for ETF stats. Their most recent report (for August) says $59.3 billion.
    http://www.cetfa.ca/infocentre/stats.html

    The mutual funds stats come from the Investment Funds Institute of Canada. They used to be harder to track down, but now it looks like they have them right on the home page. Assets under management were $926 billion as of August:
    https://www.ific.ca/Home/HomePage.aspx

    The 6% figure I used was just from dividing $60 billion by the total ($960 billion). If you want to include other investable assets that would be quite an undertaking!

  11. Steve September 18, 2013 at 7:26 pm #

    Thanks Dan!

    Re: sources, both of these are funded by their respective private members. Too bad there wasn’t an unbiased source, say Investor Education Fund, that did its own analysis. I note in their literature nowhere does it tell readers the size of each, how fast/slow each are growing, long term prospects of both. While I understand the intent is to give readers a basic overview, you cannot deny the reason readers go to an unbiased source is for help with making a decision about what’s best for them! Overall, highly impressed with IEF’s site (which I know you were a part of and likely still are 😉

    I infer from your last paragraph this information is not available, or at least not easily available. Too bad. Now that I think about it, what I really want to know is how popular are ETFs becoming in relation to all other ways Canadians can invest? And perhaps use that as a proxy for how complex Canadians find investing generally (so, I favour ETFs because I know they’re cheap and diversified and I can “set it and forget it”, but I’m not interested enough to learn the difference between market cap weighted ETFs and those that automatically rebalance based predetermined target allocations…?). I know, I know, passive is better than active, but on the flip side, could passive shoot itself in the foot by not being active enough (i.e., you really only learn why it’s so tough to beat the market and how to NOT trust your gut by… trying to beat the market and seeing where it gets you)….

    On on a similar note, is it too apples to oranges to ask how popular ETFs are in relation to other types of assets, such as real estate, bonds, stocks, etc? When I think about how I can invest my money, do I (and average Canadians for that matter) treat each asset the same when weighing which ones are best for them to invest in?

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