On the Money with Dynamic Funds

PARTICIPANTS

Peter Tomiuk
Vice President of ETF Distribution, Dynamic Funds

Alan Green
Vice President and Head of ETFs, Dynamic Funds

Mark Brisley: You're listening to the ETF Exchange, presented by On the Money with Dynamic Funds. Join us as we dive into the latest trends and investment strategies to help you navigate the ever-evolving landscape of ETFs.

Alan Green: Welcome to ETF Exchange, presented by On The Money with Dynamic Funds. This series will explore the world of exchange-traded funds, where we break down complex financial concepts into easy-to-understand discussions. Join us as we dive into the latest trends, investment strategies, and expert interviews to help you navigate the ever-evolving landscape of ETFs. Whether you're a seasoned investor or just getting started, our goal is to provide valuable insights to help you make informed decisions and grow your wealth. Subscribe now for a deep dive into the exciting world of ETFs.

Hello, everyone and welcome to another episode of the ETF Exchange podcast. I'm Alan Green, your co-host.

Peter Tomiuk: Hello everyone. I'm Peter Tomyuk, your other co-host. It's great to be back for a second episode.

Alan: Thanks, Peter. Last episode, we talked about what are ETFs and also, discussed the evolution of ETFs over the past 30+ years. Honestly, it was a bit of a history lesson, right? We touched on old James Bond movies and Roman gods and such like. Today let's bring the conversation a little bit more up-to-date and discuss what we've been seeing in terms of ETF flows over the course of 2023. First off, Peter, why should investors and our listeners care about ETF flows? Does history or ETF flow history really help us predict the future?

Peter: I think everyone's heard lines like, it's important to make informed investment decisions and follow the money. Analyzing flows is a way of checking on where the money is coming and going and that can play a part in making informed investment decisions. It can really help with things like determining investor sentiment and just generally, be a nice data point that one can use on top of all the other analysis one does when making investment decisions. At the end of the day, Alan, the value of most financial securities are determined by supply and demand, which is money flow.

That being said, there's no such thing as a crystal ball when it comes to investing. If so, Alan, I think we'd be recording this from a tropical island. Since we're now in the middle of December, I think that could be pretty enticing. No?

Alan: I'm pretty partial to the Austrian Alps, actually, this time of year, a bit of a skier.

Peter: [laughs] Fair enough. Fair enough to each their own. Alan, you mentioned last week that you can now use ETFs as a vehicle to get access to virtually any asset class. Now that we're nearing $400 billion in ETF assets trading on Canadian exchanges, it means that there is a lot of insight that we can get from the flows that we're seeing here at home. This being the last month of the calendar year, it's perfect timing to give a year-end review of what we've seen. This can also get really complex because of how many different ETFs exist out there.

I think the goal today is to sift through the rubble and keep this high level and categorize flows into some broader and familiar categories with the hope of helping everyone listening in make sense of it. I'm going to get things started. High level. As of the end of November, we had $38 billion of net inflows in the Canadian ETF industry. We still have one month to go. From what I see, we should end up with more than the $35 billion that entered the industry last year and will probably have the second highest net inflows in the history of the Canadian ETF industry. The highest being in 2021 when we saw a whopping $53 billion of inflows.

The big difference this year versus that mammoth 2021 year is that fixed income ETFs are dominating the flows. This is the second calendar year in a row that this has occurred. Alan, a big reason why this has been happening has a lot to do with what you ended our last conversation talking about, and that's cash ETFs. More specifically, high interest savings account ETFs have been dominating flows all year. Can you speak to us as to why you feel this has been the case and also discuss some of the recent regulatory developments that have occurred over the last month regarding those HISA ETFs?

Alan: Yes, I definitely agree with that. 2023 was the year that cash is back. One of the benefits of global banks increasing interest rates was that finally cash actually paid you return, right? Novel. Unlike the very dark days of the post-financial crisis, where in some cases interest rates actually went negative. Although at the time, I guess I did like the idea of taking out a large mortgage that actually paid you to have the mortgage. It definitely messed with your head at the time. Anyway, with the rate rises, ETF issuers are always quick to fill the product gap and launched ETFs that invested in bank deposits and in turn, paid that interest return to the ETF investors. A simple yet super popular product with investors and we went from zero to over 20 billion in assets very, very quickly.

The issue was that banks were treating the ETF deposits like stable and sticky bank deposits, thinking, something like your checking account, right? They pay above the overnight rate for those deposits. That's great news for ETF investors, but it probably wasn't right. ETFs are daily and even intraday liquidity vehicles, right? We talked about that in the first part. The ETF investors could sell and pull their money at any point and that doesn't marry up to how banks were treating their deposits. Our friends at OSFI, that's the Canadian bank regulator, have come in and written a brand new set of rules for banks that are specifically designed for cash ETF deposits.

Basically, what these new rules mean is that banks have to treat ETF deposits if they could walk out of the door at any point. That's much more in line with how ETFs work and operate. These new rules come into force in Jan '24, so we expect to see the cash ETF rates come down much more in line with where overnight rates are. The industry estimates this to be around a 50 basis point or half-a-percent drop in yields and we'll keep an eye on where they actually land. That's a fairly large drop and could prompt investors to redeploy some of this 20 billion capital in other areas of the market. I think this could be a big trend in 2024.

Back to you Peter, humble but return-paying cash hasn't been the only thing of interest in fixed income. What else has been going in bond land?

Peter: No, you're absolutely right, Alan. I've seen a lot of evidence of something I call a barbell within fixed income flows. We know that bonds and fixed income tend to have maturities and durations. Cash is considered to have zero duration. That's one end of the barbell, the short end. I'm seeing a lot of evidence of flows going on in the opposite end, which is longer duration, especially when looking at flows in the US. These are ETFs that are holding longer term bonds as their underlying portfolio. Now I find this fascinating. I might be the only one, but I do find this fascinating.

I'm going to get a little fixed income 101 here. Bond prices have an inverse relationship with interest rates, meaning that when interest rates go up, bond prices go down and vice versa. The degree of how much your bond prices change will be a function of duration. If you have a longer term bond ETFs, the price of that ETF will be more sensitive to changes in interest rates. I think we all know that rates have gone up dramatically in the last couple of years, primarily due to central banks adopting a rate hiking policy. These longer duration ETFs have really felt a lot of pain. We've been seeing flows going into this beaten up area of the market.

If I had to make a guess why, I would say it's due to a cohort of investors believing that rates are close to peaking and that central banks may pivot to a more dovish stance where they may be inclined to start reducing rates in the future. Central banks tend to lower rates as a tool when the economy is approaching or in a recessionary environment. Now there's more to it than that, but keeping this discussion high level, it explains the contrarian rationale as to why we're seeing flows in that area of the market.

Alan, I want to pivot a little and start talking about equities. I mentioned earlier that for the second year in a row, equities have been seeing less flows in fixed income, which is a bit of an anomaly when looking at flows over the last decade. What do you attribute this to?

Alan: Again, I think 2023 is that bit of anomaly, right? It's the second calendar year where equity ETF flows will be substantially less than fixed income. Again, that's typically against what we see. ETF flows obviously mirror investment sentiment, right? When you consider that most major equity markets are still down from the highs of two years ago, and there is, or maybe, I don't know, it depends on who you talk to, there's still fear of a looming recession. I think those flows make sense, right? It was a bit gloomy out there, especially at the start of the year.

Now that being said, we are seeing some glimmers of light and potentially some green shoots of recovery in equity ETF flows. There have been some strong inflows within the space in recent weeks, and especially in the international equity space. As at the end of November, over half of all equity net inflows this year were into ETFs that invest in companies that trade outside of North America. Now again, referencing the session, the first pod we did, we touched on how ETFs are that fantastic vehicle for investors to get access to markets that are less accessible to Canadian investors. These flows show investors doing just that, using the ETF vehicle to deploy capital overseas easily, safely, and efficiently.

In addition to that we had a stellar November equity rally. I think that was based on the market assuming that central banks are done, rate rises are on pause for the time being and we've seen or recently seen an emergence of flows into both US and Canadian equity ETFs. I think it'd be interesting to definitely look out and see if that trend continues and again, I think the other big thing we'll be watching is that if fixed income flows continue to outpace equity flows as this trend is definitely an exception to the rule. Peter, we've, I guess talked about traditional, shall we say asset classes in the ETF industry which are stocks and bonds. What else have you seen out there?

Peter: There has no doubt been an increase in alternative or specialty style ETFs. I classify these ETFs as not being traditional stock or bond ETFs but ETFs that may incorporate more sophisticated tools like hedging, leverage, alternative asset classes with a variety of goals that can range from enhancing income, protecting portfolios from downside market risk and a whole variety of other things. Within this area of the market, there is no doubt that covered call or covered option strategies have been increasing in popularity.

We're not only seeing this in the amount of assets raised but also the amount of new products being created. There are now nearly a 150 tickers of these type of ETFs trading on major Canadian exchanges. It almost feels like, every month there are a handful of these products being created. That being said, these are strategies that are oriented towards generating high levels of income, oftentimes, in a tax-efficient way. It's perfectly understandable why they would interest investors. However, they can be complex. That's where it pays to have a financial advisor steering you in the right direction because it's extremely important to understand them fully before investing in them.

Lastly, I know that cryptocurrency ETFs are of interest to some investors. As of this time, Bitcoin is valued at above $40,000 after being below $20,000 for a while, so that's starting to regarner some interest. We've seen about a billion dollars enter the space this year, most of that very recently. That's a drop in the bucket compared to 2021 when we saw about seven billion dollars enter that space. One thing about crypto, the asset class itself can be volatile and that tends to translate into some erratic flows. As of the end of November, cryptocurrency ETFs represented about four billion dollars of the total 370 billion dollar Canadian ETF industry which is just a tad above 1% in total assets.

Alan: Thanks Peter, definitely a lot going on in that space and I think we'll touch on that in future pods. With the time where it is, I'll say a few words to conclude this episode. First up, I personally always think it's very good and healthy to look back at flows and honestly, spend some time reading the ETF tea leaves. It shows where we've been and really how folks are positioned. A couple of things, I took one, firstly you're interested to see if those strong fixed income flows continue, especially that barbelling right in cash and long duration. I'm curious to see how that evolves.

Secondly, what's going to happen in equities. It was definitely a light year overall. I think that matched sentiment but we've definitely seen some of those green shoots of recovery and glimmers of positive momentum in the space. With that, we'll sign off.

Peter: Alan, I really enjoyed our exchange. We really tackled important topics like what is an ETF, where did they come from and how have they evolved? We also tackled on why they've evolved. A lot of that has to do with the continuous changing needs of investors, the increasing sophistication of the marketplace and demographics. It's exciting to see that ETFs in their current state are excellent tools to address the needs of today's investor. I expect that as ETFs continuously evolve, they will just get more and more effective in addressing investor needs of the future. We're approaching the end of the calendar year. Stay tuned because in our next ETF Exchange podcast, we are going to elaborate a little more on what we've been seeing flow-wise in the Canadian ETF industry over the last year and we might even take a stab at what we expect to see in the year ahead. Until then, thank you very much for listening in to the ETF Exchange and see you next time.

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