Christian Charest: For Morningstar, I'm Christian Charest. It's been three years since Morningstar released its framework and naming conventions for factor-based investing -- what we call strategic beta. And now Morningstar just released a sweeping global study that looks at the state of strategic beta ETFs around the world. I'm here today with Ben Johnson, Morningstar's Global Director of ETF Investing, to talk about some of the findings in that study.
Now Ben, the name we are trying to push may not have caught on, but the funds themselves certainly have. What has the growth been like.
Ben Johnson: We've seen pretty tremendous growth within the realm of strategic beta ETFs over the years, to the point now where there are more US$700 billion of investors' hard-earned dollars invested in these exchange-traded funds. We've seen the number of funds mushroom as well to now where we see more than 1,300 of them available across a variety of markets in all corners of the globe.
Charest: Now in Canada the growth rate in recent years has been comparable to the global figure, but we had a bit of a late start, and the absolute numbers are still quite low.
Johnson: So, what we see in the Canadian market is really on trend with what we've seen in other marketplaces, starting off a lower base relative to the United States where the vast majority of investors' assets and strategic beta ETFs are located today. Now that said, the trajectory has been quite similar, the growth in market share has been quite marked, and what we see is that not unlike in the U.S., not unlike in Europe, not unlike in Asia and in Australia and all of the various corners of the globe where we measured the growth of these particular funds, is that more and more investors are looking for something more than just plain-vanilla market-capitalization-weighted beta exposures. They are looking to make an active bet relative to that market-cap-weighted benchmark. They are looking to do it in a means that is very systematic, very transparent, and in most cases very low cost relative to traditional active management, and this is what strategic beta ETFs present -- this sort of opportunity for investors in Canada and the states and all corners of the globe.
Charest: Morningstar divides strategic beta funds into many different sub-groups. What are some of the more popular ones in the Canadian marketplace.
Johnson: What we see in the Canadian marketplace echoes again what we see in other markets: at the very top of the ranks of the lead table are dividend-oriented exchange-traded products. These are bolted on to benchmarks that look to isolate and build a portfolio that is intended to derive greater equity income versus owning the market at large, be it more reliable, be it as a higher yield, you name it. This is really not surprising if you consider it in the context of the prevailing uber-low interest rate environment that we see in virtually all geographies today. We've got a wall of retirees that is now coming at the point where they are no longer generating income using their human capital and want to source income from their financial capital. Rates are low, and they are looking now to bond-like stocks -- and I'll use that term very lightly and urge you to remember that stocks are no way bonds -- as evidence of the fact that people are reaching into the equity jar to generate that income from their financial assets.
The other key category, a sub-category of strategic beta ETFs that's seen significant growth within Canada, is equal-weighted strategies: strategies that start with the same universe as the market-capitalization-weighted benchmark, but do not weight those component stocks on the basis of their market cap. They give them all equal weight, which is quite understandable in the case of the Canadian market, where you see today -- and certainly historically -- significant either single-security or sector-level concentrations. Equal weighting is a quick and easy fix to diversify away your risk of having great exposure to some of the market's largest names, which we know full well do not work out well in the case of the Nortels and Research In Motions of the world.
Charest: Now most of the assets are concentrated in a handful of ETF providers, iShares and BMO being the main ones. But there are also a lot of smaller providers of strategic beta ETFs in Canada that have very low asset levels. Is that unusual compared to other countries, and how do you think that situation is going to evolve.
Johnson: Well this is another trend that resonates with what we are seeing elsewhere in the world. We see new entrants coming into this space day-by-day. In some cases they are honest to goodness new entrants. They are unknown quantities. They are new entrants into the asset management arena at large. In other cases, these new entrants are actually incumbents in the asset management arena. They may be making their first foray into exchange-traded funds, they see that the market for broad-based exposures has long since been covered off so they are looking to take their own process with respect to active security selection, and they look to codify quantitative models that maybe they have been running in-house for quite some time. Bring that into an index format or perhaps not. We've seen significant growth just outside the strategic beta bucket within Canada, within quant active equity strategies, the likes of which are offered by RBC that fail to meet our definition, but are certainly close cousins to strategic beta.
So many of these providers will continue to come to the market, will be new to the market. Some will succeed others will fail. The ones that succeed will in all likelihood be those that bring sensible time-tested strategies to the market, price them appropriately and have the patience, and know full well that not unlike active strategies, strategic beta ETFs will have periods of out and underperformance and that investor behaviour -- the ability to stick with it -- is really what matters most. And the investors can only stick with these funds as long as the sponsors are out there to support them, to educate investors on how best to use them within their portfolios. So, the patient, the steady sponsors that bring these funds to bear at a low cost for investors, and hold investors' hands for better or for worse throughout these performance cycles, I think are the ones who are ultimately going to succeed within this space.
Charest: Ben, it's always a pleasure to hear your insights on the Canadian ETF market.
Johnson: Thanks for having me.
Charest: And there will be a copy of the full research right under the video player. For Morningstar I'm Christian Charest. Thank you for watching.
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