Daniel Straus, head of ETF research and strategy at National Bank Financial

Focus: ETFs

 MARKET OUTLOOK

The Canadian ETF market now has over 850 products and $182 billion in assets, and we expect those numbers to keep growing. With the entrance of Accelerate, Picton Mahoney and Emerge since April, there are now 38 ETF providers in Canada. Providers have launched a raft of new alternative ETFs that only recently became available thanks to regulatory changes governing mutual funds in Canada.

Canadian ETFs saw inflows of $12 billion year-to-date, slightly surpassing the figure from the same period last year. Considering the volatility and uncertainty in the market this year, the pace of growth of the ETF industry remains healthy. So far in 2019, fixed income flows more than double that of equity, except for high yield credit products—a possible signal of underlying unease among ETF investors in Canada.

But not all is gloomy. In The U.S., total ETF assets under management crossed the US$4 trillion milestone (that’s trillion with a ‘T’) before dipping back to US$3.9 trillion on backsliding market action. Despite growing volatility, rising alarm over inverting yield curves and disappointing industrial production, National Bank’s economists and strategists write that the U.S. economy isn’t “as bad as advertised.” As a counterpoint to the prevailing pessimism, they point to a buoyant labour market, higher personal savings, low debt ratios, declining interest rates and a “sound financial system” paving the way for thriving consumption.

National Bank’s economists also bring evidence for optimism within domestic markets with employment up an impressive 223,000 for these seven months of 2019, with mostly new full-time jobs. Wage inflation is up, profits are surprising to the upside and the Canadian household sector stands on firm ground.

Canada and the U.S. might offer investors hope, but international markets might puncture our attempts to oppose the bearish consensus narrative. There’s no whitewashing the fact that headlines around the trade war are driving markets through peaks and valleys of confusion. The possibility of a no-deal Brexit is weakening the British pound, tensions are rising between South Korea and Japan, and Hong Kong protests are stoking regional fears. Taken together, the geopolitical picture looks as cloudy as ever. That’s why we’re choosing to highlight a Canadian equity ETF, a U.S. equity ETF and a fixed income ETF in today’s program.

Speaking of fixed income, the Fed delivered the anticipated 25 basis points (bps) rate cut in its July meeting and the bond market is living with the aftermath. The chair’s reference to a “mid-cycle adjustment” threw cold water on the idea of further dovish action, but the ensuing market fit has pulled forecasts out of focus. That said, our economists see two more rate cuts in the U.S., not four, and none in Canada, where the economy is strong. We’ve seen some curve flattening in Canada, but not as pronounced in the U.S. and hard economic data is still not “flashing red.” We published an ETF research note on July 24 (Called ETF Trade Ideas ahead of Fed Easing), where we highlighted different ETF selections to inform investors on some ways to position for the Fed meeting. Since that note was published, our aggregate bond picks for the “consensus” scenario had positive price appreciation of 1.5 per cent to two per cent.

TOP PICKS

ISHARES ESG MSCI USA INDEX ETF (XSUS:CT)

ETFs that incorporate environmental, social and/or governance (ESG) factors in the investment process have seen tremendous growth. The product choices in Canada have expanded to include both niche focuses and broad coverages. In addition, the investment costs (such as fees) for such products have come down significantly, allowing investors to incorporate ESG without being penalized by excessive fee drag.  One can now build an ESG-conscious portfolio while still meeting the risk, return, diversification and cost profiles of a traditional portfolio. The newly launched suite of iShares ESG ETFs aim to maintain a similar risk-adjusted profile as the broad benchmark while providing improved ESG scores. The funds follow the MSCI Extended ESG Focus indices and charge low annual fees ranging from 20 bps to 35 bps.

MACKENZIE MAX DIVERSIFICATION CANADA INDEX ETF (MKC:CT)

This ETF follows a patented methodology developed by the quant managers at TOBAM, a Paris-based institutional asset manager. The idea behind this index is to construct a sub-portfolio of Canadian companies that are as diversified from each other as possible. Given that the Canadian equity market has a history of sector concentrations, the idea of tilting toward “diversification” can make some sense. TOBAM’s index methodology also includes an ESG investment screen through the application of Norges Bank’s recommendations and exclusions.

FRANKLIN LIBERTY GLOBAL AGGREGATE BOND ETF CAD-HEDGED (FLGA:CT)

This ETF invests primarily in investment grade government and corporate bonds globally, but may invest up to 20 per cent of its assets in high-yield securities. Its benchmark is Bloomberg Barclays Global Aggregate CAD-hedged index and the portfolio manager aims to add value through sector allocation, duration management, currencies exposures and security selection while limiting tracking error. This strategy is managed by Franklin Templeton’s European Fixed income team based out of London, UK. At 0.38 per cent, this actively managed ETF can be used as a core bond allocation for those investors who are worried about distortions in a “passive” index-tracking bond strategy.

PAST PICKS: Oct. 18, 2018

HORIZONS S&P/TSX 60 INDEX ETF (HXT/U:CT)

• Then: $32.54
• Now: $35.54
• Return: 9%
• Total return: 9%

VANGUARD GLOBAL VALUE FACTOR ETF (VVL:CT)

• Then: $33.67
• Now: $29.82
• Return: -11%
• Total return: -9%

INVESCO LOW VOLATILITY ETF (PLV:CT)

• Then: $21.43
• Now: $23.26
• Return: 9%
• Total return: 11%

Total return average: 4%