Roundtable - Benefits Canada.com · Roundtable The 2008 financial crisis has been a game changer for ... from experts at our 2016 ETF Roundtable, where we also ... To Warren’s earlier

ETFRoundtable

The 2008 financial crisis has been a game changer for exchange-traded funds in the pension space. As plan sponsors hunt for liquidity and access to new asset classes and strategies, ETFs have evolved from their largely tactical role in pension portfolios (think cash management) into a much more strategic position. That’s the main finding from experts at our 2016 ETF Roundtable, where we also talked about the growing role of ETFs as a substitute for derivatives and as a means of gaining exposure to the expanding fixed income universe. And as consultants bring them into the investment conversation and their track record expands, it looks as if ETFs have finally come into their own in the Canadian pension landscape.

EXCHANGING PLACES ETFs taking a strategic place in pension portfolios

2 Sponsored Supplement | ETF Roundtable

EXPERT PANEL

WARREN COLLIERManaging Director, Head of iSharesBlackRock Canada

BOBBY ENGVice President, Head of SPDR ETF Business Development – Canada Global SPDR BusinessState Street Global Advisors

STEVEN LEONG, CFADirector, iShares ProductBlackRock Canada

MARK RAESHead of Product, ETFs and Mutual Funds BMO Global Asset Management

ROBERT TRUMBULLManaging Director, Head of Asset Owner ETF SalesState Street Global Advisors

ETF Roundtable | Sponsored Supplement 3

The past five years have been pivotal for institutional ETF usage — what’s changed and how have institutions come to use ETFs in their portfolios?

Warren CollierThe fallout from the financial crisis has given ETFs a tailwind in the institutional and pension space over the past five years. Regulatory pressure has meant banks have pulled back from their role as financial intermediaries — ETFs have filled the gap with a lower-cost alternative to a traditional derivatives instrument. We’ve also seen a steep rise in fixed income ETF use as well.

Robert TrumbullConsultants are also talking to plan sponsors and embracing ETFs in a way they didn’t in the past, whether it’s through traditional investments or through the outsourced CIO model. At the same time, plan sponsors are now using ETFs more strategically instead of tactically, as they seek very specific portfolio exposures and increase their use of new and innovative strategies.

Mark RaesThe institutional use has always been there. What you’re seeing now is greater depth in the market as different types of institutions start using ETFs — small and large pensions, endowments, asset managers. The spectrum of players starts to change the market — there are more products to choose from, and those products and the providers are gaining a longer track record, which appeals to institutions. You’re not going to feel confident unless a product has some history to it.

Bobby EngInstitutions are becoming more comfortable with ETFs, from the access to liquidity, transparency, trading flexibility and just the ease of getting exposure to the various different asset classes. And to Rob’s point a little earlier about going more strategic, we’re seeing that shift happen as well in Canada. Institutions are shifting from a much more tactical position to a more strategic use of ETFs, with ETFs being held for a couple of years instead of just a few months.

Last year raised a lot of questions around ETF liquidity, particularly in the bond space — how are these challenges being addressed?

Robert TrumbullTo Warren’s earlier point, fixed income ETFs have stepped in to become an important source of liquidity for asset owners as banks have reduced their inventories.

More institutions are considering converting their bond inventories to ETFs to increase their level of flexibility and reduce trading costs. You compare the bid-offer spreads of the bonds in a fixed income ETF with the ETF itself and in some cases they can be significantly lower.

Warren CollierWhen people don’t fully understand how fixed income ETFs work, they ask, “What happens if something goes wrong and everybody wants to redeem and you, as a manager, need to sell?” That’s because sometimes, during a crisis, you may see the reported net asset value of the fund diverging from its market price simply because the underlying bonds aren’t trading while the ETF is. But, as we’ve seen, when those underlying securities start to trade, the net asset value catches up to the market price.

It’s become clear that, during times of crisis, ETFs become another tool for the transfer of risk. But, in the worst case scenario, because ETF managers don’t sell bonds on a redemption, but instead deliver the basket of individual bonds, investors will end up in the same position as if they had held the individual bonds all along, and ETF’s won’t add new liquidity to the underlying securities.

Institutions are shifting from

a much more tactical position

to a more strategic use of ETFs,

with ETFs being held for a

couple of years instead of just

a few months.”

— Bobby Eng


Mark RaesAs the ETF market matures and grows, in some cases ETFs are adding more liquidity to the underlying assets. You look at high yield for example — in the past, if you tried to trade a basket of underlying bonds during a time of market stress, good luck. But during 2008, you saw continued trading in ETFs — a vigorous bid-ask market where investors could enter and exit positions in a way they couldn’t do with the underlying.

Robert Trumbull“What happens in a time of crisis?” is the most common question we get about fixed income ETFs. It reflects the fact that the first ETFs were based on equity indices — they took a relatively transparent security already traded on an exchange and provided an even more transparent, more flexible way of getting exposure to it. The fixed income market, however, is opaque at best — ETFs are providing transparency and that has shone a light on the inefficiencies that already exist in the fixed income space.

Bobby EngLiquidity has been a concern for many institutional investors in general but it’s an opportunity for us to educate the marketplace on those exact points — talking

about creation and redemption, and primary and secondary market liquidity, and walking investors through what happens during times of stress. It’s also a great opportunity to shine a positive light on how ETFs can be beneficial to the fixed income market.

How can plan sponsors decide when to use ETFs and when to invest directly?

Warren CollierIt comes down to the total cost of ownership. There are commissions, there are embedded fees and there are spreads. On any given day, it may be better for you to get exposure to a particular geographic market through direct physical securities, ETFs or even through a futures contract. To decide what the best route may be, you need to have the tools to measure the total cost of ownership. At the same time, from a risk-management standpoint, it is very easy to understand exactly what you own on a minute-by-minute basis using ETFs; with some other vehicles it can be much more difficult.

Steven LeongThat’s a very good point — the big public plans have the tools to analyze the total cost of ownership in real time, but the smaller you get, the fewer resources you have available. You become much more dependent on the consultants to help you understand when an ETF makes more sense than a physical security.

Mark RaesIt’s also about how you’re using them. Investors using ETFs for tactical reasons are looking at ease of entry and exit, with exit probably being the more important question. Strategic users, however, are looking at the longer-term costs relative to holding physicals and trading.

Total costs are clearly important — how do ETFs measure up for Canadian plan sponsors from a cost standpoint?

Warren CollierETFs are a democratizing delivery vehicle — the price you see on the website and the price you see in the newspaper is the price you pay. For those core exposures, they are very competitive with other vehicles. But it fundamentally comes back to how long you want to hold them and why you’re holding them. Plus, how expensive are the alternatives?

Robert TrumbullSecurities lending has become an important component of ETF ownership for pension funds. If you’re long on an

ETFs are a democratizing

delivery vehicle — the price you

see on the website and the price

you see in the newspaper is the

price you pay.”

— Warren Collier


ETF and you’re holding it, you can allow that position to work on your behalf through lending. The more costly the exposure is to bundle up and package, the better you’ll potentially do in terms of lending it out. More plain vanilla exposures garner lower lending revenue, but even if you’re looking at an S&P 500 ETF and it’s giving you two, three or four basis points, then lending still significantly reduces your cost of ownership.

Bobby EngSecurities lending is definitely a growing part of managing the total cost of an ETF — the management fee can be roughly 20–30 basis points, but if there’s a significant borrow demand, you can often make up a good portion of the management fee by lending those securities out.

Mark RaesIt’s important that the ETF conversation has evolved to total cost instead of just management expense ratio (MER). I think five years ago a consultant would show plan sponsors a list of ETFs by MER from lowest to highest and the obvious pick would be the cheapest. Now they’re having a fuller conversation not just around the ETF but around what they’re comparing it to. And they understand that the total cost during the holding period is part of that.

Steven LeongIt’s worth noting that ETF headline costs are converging toward more traditional institutional pricing, with products available in a range that’s below 10 basis points. But the things that you’re really saving on, which don’t get as much attention, are the administrative costs and overhead, whether they’re legal contracting or manager supervision activities that go with alternatives to ETFs. Those can be a real burden for plan sponsors.

How are plan sponsors using smart beta ETFs?

Robert TrumbullI think the backdrop of the smart beta conversation is lower for longer. Are there ways to add value beyond traditional exposure but at a much lower cost and passively implemented relative to skill-based managers? And how much value do active managers add versus a low-cost, passive factor? Right now, plan sponsors are looking at specific areas where factors make sense.

Mark RaesBut first you have to define that factor and then decide how you invest in it. Also, how do you screen for that factor? With so many products, indices and methodologies out there, it can be hard to know what you’re getting. For plan sponsors, that can be daunting. What’s been more

helpful is the evolution toward a multifactor approach based on a desired outcome. This creates a more helpful conversation than simply deciding which factor to chase right now because it’s doing better.

Steven LeongThe whole concept of smart beta is a catch-all for everything that isn’t market-cap weighted. We are seeing much more interest in multifactor approaches that smooth out performance over different markets. For example, there will be a time when low volatility doesn’t do well and other factors like quality and value will come back into favour.

Warren CollierFactor investing now is where asset al location was in the mid-’80s — everyone knows it makes sense; the questions are, how do you benchmark to it? How do you measure your successes of the plan? How do consultants rank providers? We’re sti l l at the early stages of f iguring that out.

Investors using ETFs for tactical

reasons are looking at ease of

entry and exit, with exit probably

being the more important

question. Strategic users, however,

are looking at the longer-term

costs relative to holding physicals

and trading.”

— Mark Raes


Robert TrumbullIt comes back to what the client is looking to achieve; for some, it’s about risk-adjusted returns, while for others, it’s cost versus an active exposure. Plan sponsors need to understand basic index construction methodology. There are a lot of different ways to build these indexes and each index provider has a different method. The key point is, again, matching investor expectations and outcomes to the actual solutions.

What about ETFs for emerging markets exposure — they are a growing part of these markets. Are they appropriate for pension funds?

Steven LeongThe really short, easy answer is yes. Increasingly, pension plans in Canada are adding emerging markets ETFs to their portfolios. The benefits of the sort of easy, liquid access to that asset class are really very compelling compared to the sort of clunky mechanics of a pooled fund or some other institutional vehicle. The trading costs and account openings and currency controls — they all add up to a lot of

friction that comes with dealing with emerging markets. An ETF simplifies that — plan sponsors can trade one security either in Canada or the U.S. and get the entire market. And those benefits are real, even before you consider the additional securities lending benefits.

Warren CollierI probably have more conversations about equity ETFs in the emerging markets space but debt is now becoming part of the discussion. Given that not all emerging markets are created equal and each one is going to react to market events differently, plan sponsors need to take a more nuanced approach and target specific areas. ETFs are particularly valuable in this context. At the same time, the securities lending opportunities are incredibly lucrative.

Mark RaesWhen you start looking around the globe and you look for market exposure, ETFs really are a go-to vehicle because of the liquidity, transparency and execution benefits. The harder a market is to access, the more sense an ETF makes.

Steven LeongEmerging markets exposures are definitely getting more specific — ETFs are a good option because it’s hard to find managers based in Canada who specialize in some of these areas, like Asia or Latin America. At the same time, it’s hard to underestimate how important China is from a global macroeconomic perspective — but it’s a very difficult market to access. That’s where ETFs are also gaining traction.

Warren CollierThe more opaque and the less liquid a market is, the more value ETFs bring. There are some issues plan sponsors need to be aware of though — currency is one of them. And the fact that there are different holidays and time differences between markets.

Where do you see ETF use evolving in the future?

Bobby EngThe acceptance of ETFs within the institutional market has grown and it’s impressive, but it’s really just early innings. There’s no question that fixed income is going to be a major driver of that growth as institutions become more educated and comfortable. New products will likely be more niche oriented. ETFs will help with getting exposure to very specific asset classes and specific areas. We’ll see that evolve over the coming years.

Mark RaesThe future will be about more global exposures and more precise exposures. So it might be a deconstruction of

The fixed income market,

however, is opaque at best —

ETFs are providing transparency

and that has shone a light on the

inefficiencies that already exist in

the fixed income space.”

— Robert Trumbull


emerging markets debt. It might be more global bonds segmented by maturity and other factors. ETFs will give investors more precise tools that they don’t currently have. Coming out with another S&P 500 ETF is all well and good, but there’s already enough out there so it won’t continue to capture investors’ interests in the same way. People will look for new and exciting opportunities to really open things. Warren CollierI think factors are in the early days. Everyone is right about multifactor exposures as the next big thing in the institutional space. Almost all of the flows so far have been into single-factor products as internal managers deploy their own skills to put different factors together. But there’s a lot of room to grow in this area.

Robert TrumbullEnvironmental, Social and Governance (ESG) is an area in which we continue to see increased interest. Institutional investors are focused on ESG factors, such as carbon as a risk factor, and the discussion is migrating from purely an ethical lens to an economic lens. Another area of focus has been on gender diversity and the observation that companies with a greater level of diversity of thought perform better over time. We’re already seeing investors start to act in both of these areas and I believe that we will continue to see them focus on building their portfolios with a conscious eye toward ESG.

Steven LeongI agree that fixed income is going to be a huge part of future growth. Relative to equity ETF, fixed income ETF allocations are still very small — something like 1% relative to 3% for equities. So there’s a lot of product innovation that’s still to come in the fixed income space. I also think there’s a lot of room for more truly objective factor products and products that will innovate around long holding constraints. We will also likely see ETFs begin to

democratize the illiquid space — infrastructure, property and other kinds of alternatives. It took a long time to figure out how to turn bonds into an ETF, but I’m very confident that, over time, ETFs are going to bring transparency and liquidity to some of those other liquids as well. There are a lot of real world problems to solve, but I’m confident that the industry will do it. l

Emerging markets exposures

are definitely getting more

specific — ETFs are a good

option because it’s hard to find

managers based in Canada who

specialize in some of these areas,

like Asia or Latin America.”

— Steven Leong


BlackRock BlackRock is a global leader in investment management, risk management and advisory services for institutional and retail clients. At June 30, 2016, BlackRock’s AUM was US$4.890 trillion. BlackRock helps clients around the world meet their goals and overcome challenges with a range of products that include separate accounts, mutual funds, iShares® (exchange-traded funds), and other pooled investment vehicles. BlackRock also offers risk management, advisory and enterprise investment system services to a broad base of institutional investors through BlackRock Solutions®. As of June 30, 2016, the firm had approximately 12,700 employees in more than 30 countries and a major presence in global markets, including North and South America, Europe, Asia, Australia and the Middle East and Africa. For additional information, please visit the Company’s website at www.blackrock.com/ca. iSharesiShares® is a global leader in exchange-traded funds (ETFs), with more than a decade of expertise and commitment to individual and institutional investors of all sizes. With over 700 funds globally across multiple asset classes and strategies and more than US$1 trillion in assets under management as of June 30, 2016, iShares helps clients around the world build the core of their portfolios, meet specific investment goals and implement market views. iShares funds are powered by the expert portfolio and risk management of BlackRock, trusted to manage more money than any other investment firm.1

1 Based on US$4.890 trillion in AUM as of 6/30/16.

BMO Financial GroupEstablished in 1817, BMO Financial Group is a highly diversified financial services provider based in North America. With total assets of $681 billion as of April 30, 2016, and over 45,000 employees, BMO provides a broad range of retail banking, wealth management and investment banking products and services to more than 12 million customers and conducts business through three operating groups: Personal and Commercial Banking, Wealth Management and BMO Capital Markets. BMO Exchange Traded Funds (ETFs) Established in June 2009, BMO Financial Group’s ETF business is a leading ETF provider in Canada. Since its inception, BMO ETFs has grown to over 60 funds, and includes several industry firsts. The ETFs provide Canadian investors with broader choices and greater access to an innovative portfolio of investment products. BMO ETFs have over $30 bill ion in assets under management, as of June 30, 2016.

State Street Global AdvisorsFor nearly four decades, State Street Global Advisors has been committed to helping our clients, and those who rely on them, achieve their investment objectives. We partner with many of the world’s largest, most sophisticated investors and financial intermediaries to help them reach their goals through a rigorous, research-driven process spanning both active and index disciplines. We take pride in working closely with our clients to develop precise investment strategies, including our pioneering family of SPDR® ETFs. Our scale and global footprint provide access to markets and asset classes, and allow us to deliver thoughtful insights and innovative solutions.

SPONSORED BY

Documents

Roundtable - Benefits Canada.com · Roundtable The 2008 financial crisis has been a game changer for ... from experts at our 2016 ETF Roundtable, where we also ... To Warren’s earlier