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Why wealthy investors are jumping into ETFs, once the domain of Main Street

The features that first made ETFs a good Main Street product are now driving popularity with millionaires

“The rich are different from you and me.” F. Scott Fitzgerald is supposed to have once made this observation to Ernest Hemingway, who replied: “Yes. They have more money.”

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Unfortunately, this story, like so many of the best, is too good to be true. But it does point to the general belief that wealthy individuals do things differently, notably when it comes to investing. After all, the thinking goes, they can afford the investment minimums and fee structures that come with sophisticated money management.

That might have been true once upon a time, but times are changing. Wealth managers report that high-net-worth investors are now favouring the humble exchange-traded fund as a key asset class in their portfolios.

“There’s an unquestionable trend in the marketplace that ETFs are increasing in popularity,” said Rod Heard, co-founder and chief executive of Calgary’s SmartBe Wealth Inc.

Indeed, ETF sales in Canada jumped to a record-setting $40 billion in 2020, from $28 billion in 2019, according to a National Bank report, a major signal in Heard’s view that “ETFs are gaining popularity with high-net-worth individuals.”

It’s difficult to put hard numbers on the trend, but anecdotal evidence and broad industry sales flows show it’s there. The question is: Why? ETFs, after all, are traditionally thought of as a product for Main Street investors. They’re low-maintenance products designed to simply match the performance of a given benchmark — originally, indexes such as the S&P 500 or TSX 60 — for much lower fees than one would pay for units in, say, a mutual fund that does a similar job.

In contrast, high-net-worth investors are usually considered more sophisticated on money matters. They can afford the fees charged by individual brokers and advisers who are supposed to have the potential to generate market-beating returns. Moreover, they’re considered better able to understand the complexities and risks of their investment strategies.

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At least, that’s how the stereotype goes. According to Pat Dunwoody, executive director of the Canadian ETF Association, the picture is changing, and, in turn creating new roles for ETFs.

“High-net-worth investors are usually using a full-service brokerage, and ETFs are growing quickly in that segment, that channel,” she said.

In other words, the relationship between wealthy investors and their brokers is evolving. Rather than acting as stock pickers and market strategists, brokers are increasingly providing a range of services that cover wealth building and issues such as tax planning, estate planning, income strategies and so on. And investing tactics are evolving alongside changing client-broker relationships.

Samuel Chinniah, a senior vice-president at Toronto-based T.E. Wealth, said his firm has been carving out a greater role for ETFs in its investment strategies over the past five years.

Before, the company invested with multi-manager funds — that is, funds that combine multiple professionally managed funds.

“But what we found over time … is that they become like closet indexers,” Chinniah said. “You have some managers who are shooting out the lights, some managers who are mediocre and some who are bad. It kind of mutes the overall return.”

Today, Chinniah and his colleagues are deploying a model that combines a shoot-the-lights-out manager with a comparable market ETF to balance out the risk. It’s an approach that’s both cost-efficient and effective, he said.

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A second factor that may be driving the growth of ETF investments among the wealthy is simple demographics: A growing number of those investors are at or near retirement age. Their goals are changing. Growth and over-performance are becoming less of a priority in favour of income and capital preservation.

“Investors are looking for less-volatile products heading into retirement,” Dunwoody said. “By nature, it would make sense to move into ETFs.”

Other factors are adding to the growth. Heard notes that Canadian investors have been slow to pick up on ETFs compared to investors in the rest of the world, where clampdowns on commission trailer fees in mutual funds have helped push investors toward ETFs.

Growing awareness of fees — as well as questions about the ultimate value of active management — are likely inspiring greater interest in ETFs here.

ETFs have also come a long way in terms of the market sectors they represent. Originally, they were seen as easy and inexpensive ways to track major stock market indexes. Now you can buy ETFs that focus on emerging markets, tech stocks, dividends, real estate, social responsibility, Bitcoin or whatever else you like. Some even replicate the strategies of famous investors.

“You can basically carve out anything you want,” Chinniah at T.E. Wealth said. “There’s no minimum investment. It’s easier to get in and get out. If you go with a manager, it’s a big process to pick a manager. It’s a big process to get in and out.”

Put another way, the features that first made ETFs a good Main Street product — flexibility, low cost, ease of trading — are now driving their popularity with millionaires. The needs of high-net-worth investors are changing as are their adviser relationships and attitudes toward active management.

Assuming these trends continue, Canada just may catch up with the rest of the ETF world.

Financial Post