Interest in exchange-traded funds (ETFs) among Canadian investors has never been higher. At the end of June, domestic ETFs held a record $217.8 billion in assets under management, while there are now 808 Canadian-made funds for people to choose from, according to the Canadian ETF Association.

With so many options on the market you might think that there’s no need for new products, but, says Bruce Cooper, CEO of TD Asset Management (TDAM), that’s not so. 

Despite the product explosion that’s taken place over the last decade there are still gaps in the marketplace, he explains.  

“While the ETF industry has evolved significantly over the years, there’s a lot of room for growth,” he notes. “There are still many underserved areas of the market.”

While passive ETFs, such as ones that track the S&P/TSX Composite Index, will likely never go out of style, people need more than just a couple of all-purpose products to help meet their increasingly complex retirement needs, says Cooper. For instance, there’s going to be much more demand for income-producing offerings over the next decade. 

“With interest rates at historic lows, one of the biggest challenges for investors over at least the next 10 years, is income,” he explains. “It’s going to be incredibly difficult for savers, so the ETF market must meet the challenge by creating better products.”

There’s also a lot of opportunity for more innovative funds in the actively managed space. Actively managed ETFs are similar to passive ones in that they trade on an exchange and come with attractively priced fees, but they’re overseen by professional managers who can incorporate different kinds of strategies to help reduce risk and enhance return. 

“There are a lot of places where active adds value,” says Cooper, including in fixed income, which can be a complicated area of investment. A company with managers who have expertise in assessing credit, for instance, would have an edge over others when it comes to choosing corporate bonds to put into an ETF portfolio. 

Differentiation is key 

The only way to fill the marketplace’s gaps is to issue truly differentiated products that investors can’t get anywhere else. That’s not always easy to do and there are too many similar products to choose from, notes Cooper. With that in mind, in May 2019 and again in June of this year, TDAM launched a number of ETFs that Cooper says take differentiation to heart. 

Some of these funds, such as the TD Active Global Enhanced Dividend ETF (TGED) and the newly launched TD Active U.S. Enhanced Dividend ETF (TUED) use an active options overlay to help create better risk-return outcomes over time.  The active nature of the fund is a key differentiator, as other ETFs take a more formulaic approach. It helps that TDAM has full discretion on their option writing. In addition to being active, the fund also employs call writing and put writing to help add income to the portfolio.  Writing puts on an active basis is also something that adds differentiation compared to some competitors.

Selling a put is like selling insurance. For example, if a stock price is $100, and you write a put at $90, someone looking to protect themselves against the stock falling may buy that put and then pay you an "insurance premium".  If the stock price falls below $90 before the expiry date, the insurance seller would have to buy the stock from the insurance buyer for that price.

This approach is “a fundamentally different strategy,” Cooper explains. “Think of it this way, in our scenario we’re selling insurance rather than buying it. When we sell the insurance, we collect income and we’re only selling insurance on properties we’d want to buy at a low price.” 

When it comes to the stocks that the ETF may end up owning, Cooper says that “these are quality companies we’d like to own for the long term. They might be a little expensive, so we don’t want to buy at the current price, but by selling puts we know we’ll be happy buying it at a lower price.” 

The TD Global Technology Leaders Index ETF (TEC) is another example of a differentiated product. When TDAM looked at the technology ETF market, they found there were too few pure play technology funds, with a majority of funds replicating the NASDAQ.  While the NASDAQ may be comprised of quality companies, some may consider it to be "contaminated" with non-technology companies, such as Pepsi, Costco, Starbucks, and even Lululemon to name a few. 1

“We kept hearing that there was a need for a purer technology exposure, and that the options on the market were not a perfect way to construct a technology ETF,” he says. 

TDAM wanted to create a fund that was globally diversified and could take advantage of the many tech trends that can drive the market for years to come. Its team worked with a German Index Engineering company, Solactive, to create a new pure play technology index, which TEC seeks to track.

Decades of investment expertise

One of the reasons why TDAM has been successful in creating more differentiated ETFs is that its team has decades of expertise in creating products. While ETFs may be new to the company, for the last 30 years, they have developed market-leading mutual funds and have built out a global team of analysts on the fixed income and equity sides, which they tap into when creating new ETFs. 

For instance, with TGED and TUED, the analysts at TDAM are integral to determining which companies to sell options on and which businesses they may want to potentially own.

“Analysts are doing the research every day, looking for high-quality companies that generate consistent free cash flow, have strong balance sheets and a competitive advantage,” he says.

On the fixed income side, TDAM is one of the most experienced firms in assessing credit. Their independent credit research team analyzes hundreds of companies on an ongoing basis to determine which ones would work best in their products. This is especially key today, when bond rates are so low. 

“You’re forced to take intelligent risks in order to grow the real value of savings, and so the clients who develop a relationship with us get our track record of investing in credit, whether high-yield or investment grade,” notes Cooper, adding that clients get the same kind of expertise in its real estate and infrastructure funds. 

While the ETF universe is only going to expand, as long as investors stick with products that manage risk while adding returns and do something different than what else is out there, they should see their portfolios rise over time. “We are not about short-term themes,” says Cooper. “We’re trying to serve clients in the core part of their portfolio. That kind of long-term investing is never going to go away.”

To learn more about TD Asset Management’s new ETF products and innovations, click here.

1 Companies that are included in the NASDAQ-100 as of July 7, 2020.  Source:  Bloomberg Finance L.P.

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