Jun 22, 2021
How innovative ETFs are filling gaps in the market and generating untapped opportunities
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Over the last year, 111 new ETFs have come to market, according to the Canadian ETF Association, including climate, cryptocurrency and innovation-focused funds. David Roode, vice-president and director of ETF product strategy at TD Asset Management Inc. (TDAM), says more are on their way.
“You just have to look at the number of mutual funds worldwide relative to the number of ETFs to get a sense of how deep the ETF market can become,” he says. “At this point, we are only scratching the surface in terms of the types of funds offered via ETFs.”
At the same time, asset managers are looking at new asset classes and new ETF structures to give investors and advisors more choice and more flexibility in how they structure portfolios.
“The industry is reaching into new asset classes, expanding beyond the traditional passive index funds that have been leading the growth of ETFs and developing new indexes to meet changing investor needs,” he says. “Asset managers and ETF issuers are developing new concepts and different approaches to asset classes that give advisors and portfolio managers more ways to express their views on the market.”
Roode’s job is to help TDAM find gaps in the ETF market and develop more innovative solutions. He looks across the investing landscape, both globally and within individual sectors, to, he says, “find products that will appeal to investors, but at the same time improve upon what’s existing.”
Healthcare is one industry that he’s been focused on. The sector is benefiting from an aging population that needs more medical services and a boom in game-changing drug-related innovations. However, while there are several healthcare ETFs on the market, in Canada and elsewhere, when TDAM looked at what was available they didn’t see anything that they thought captured the full scope of the sector, says Roode.
For instance, the two largest healthcare ETFs by total assets, both U.S. listed, hold companies across the healthcare landscape, but only invest in U.S.-based businesses. The next three largest ETFs invest in one sub-sector, such as biotechnology and medical devices.
In Canada, the largest healthcare ETF has about half of its assets in pharmaceuticals, about 80% of its funds in the U.S. and holds fewer than two dozen companies.
“When we look to build an ETF, we look at competitive funds and the structure of the industry itself,” says Roode. “This is a global business and we wanted to make sure investors had exposure across the world, to many companies that are developing new and innovative ideas. A global fund can give investors better opportunity for growth over time.”
This past April, TDAM launched their TD Global Healthcare Leaders Index ETF (TDOC), an ETF that invests in a diverse group of healthcare companies – biotech, pharmaceutical, life sciences, health services and more – around the world. With TDOC, advisors and their investors get much broader exposure to the healthcare industry than they can get elsewhere, and through a low-cost Canadian-listed vehicle.
Currently, TDOC, which seeks to track the Solactive Global Healthcare Leaders Index (CA NTR) and has a management fee of 0.35%, holds over 140 companies. 63% of its assets are in U.S. stocks, while the rest are invested globally outside the U.S., as of June 15, 2021.
As for sector makeup, TDOC has approximately 33% of its assets in pharmaceuticals, 26% in healthcare equipment and supplies, 15% in healthcare providers and services, 15% in biotech and 8% in life sciences, also as of June 15, 2021.
It does something else differently: It doesn’t have more than a 2% weighting in any one company. The Health Care Select Sector SPDR® Fund, by contrast, which is the largest healthcare ETF, has nearly 10% of its assets in Johnson & Johnson, while its top five holdings account for approximately 30% of the total portfolio, as of June 15, 2021.
The reason for this, says Roode, is that if the portfolio was weighted according to the size of each holding, then mega-cap pharmaceutical companies would dominate the portfolio.
“A cap on those companies ensures that they’re not dominating the portfolio, but still provides exposure to them,” says Roode. “Additional exposure is allocated to companies with higher growth profiles.”
Building on past success
While TDOC may have only come out this year, in the midst of a global pandemic and with all eyes on the medical industry, TDAM started talking about creating a broad-based healthcare ETF before the COVID-19 pandemic began. They saw an opportunity to help advisors and investors get exposure to a sector that’s underrepresented in Canada – healthcare makes up about 1% of the S&P/TSX Composite Index – and is often ignored by domestic investors who, in part because of our public healthcare system, aren’t familiar with healthcare names.
With an aging population needing an increasing amount of healthcare services and treatments, and with many companies working on several potentially groundbreaking innovations, this industry has a promising future, says Roode.
There’s another reason why TDAM created this ETF – they wanted to develop something similar to their TD Global Technology Leaders Index ETF (TEC), which takes that same global view to a sector that’s underrepresented in Canada and often concentrated in U.S. names.
Since launching in May 2019, TEC has amassed more than $1.5 billion in assets under management, making it the largest technology ETF in Canada, as of May 31, 2021. Similar to TDOC, Roode and his colleagues looked at the technology ETF landscape to see where existing funds fall short. They found that many of the technology ETFs on the market simply tracked the NASDAQ, which is mostly concentrated in the U.S.
With TEC, investors get easy access to a broadly diversified portfolio of technology stocks, both across geographies and sub-sectors. Healthcare, says Roode, was a natural choice for a TEC-inspired fund and the two industries share a lot of similarities.
“When you start looking at healthcare, a lot of those innovations could be classified as technology,” says Roode. “It’s not just the family doctor anymore, we’re relying much more on technology to be able to deliver services and develop drugs.”
Busting an ETF myth
One of the challenges with bringing new products to market is that some investors and advisors have a view that ETFs are not as liquid as stocks, says Tom Grant, vice-president of ETF capital markets at TDAM.
Investors often evaluate liquidity by looking at trading volume and assuming little volume means low liquidity. While that’s the right way to look at a single stock’s liquidity, it doesn't work with an ETF, which tends to have lower volumes than individual companies. With an ETF, liquidity is based on the underlying liquidity of the securities it holds.
“There’s a much richer pool of liquidity than what’s available on-screen,” says Grant. “Investors can directly interact with this liquidity with the help of a capital markets professional or an ETF market making desk.”
“We’ve had trades go through of $250 million in a day, and the reason we can do that is because the liquidity of the underlying securities is such that we can fill that order with the help of a market maker,” says Roode. “That goes into product design as well – when we design a product, we seek to ensure the liquidity is there so that you can execute on those large trades.”
With the success of TEC, TDAM hopes to take the same globally diversified approach to ETF creation with other sectors. They are always looking for new opportunities and ways to fill the any remaining gaps in the market.
“We’d be remiss to not look at replicating the TEC strategy,” says Roode. “We want to build better products and improve upon what’s out there to get the best possible exposures we can. We’re going to strive to continue doing that.”