Horizons ETFs – One of Canada’s Leaders in Actively Managed ETFs Since 2009
Understanding Actively Managed ETFs
An exchange traded fund (“ETF”) provides the best of both worlds when it comes to mutual funds and stocks. Like a mutual fund, ETFs are open-ended, meaning that new units of the fund can be created or existing units redeemed at a price per unit that reflects the market value of the underlying securities the fund holds less the liabilities of the fund. Like a stock, ETFs trade on a stock exchange and can be purchased or sold throughout normal trading hours (9:30 a.m. to 4:00 p.m.) at or near its current market value.
The first ETFs launched were designed to seek to replicate a broad index of securities, such as the S&P/TSX 60TM Index or the S&P 500® Index, just to name two well-known examples. Since there is no expectation of trying to outperform these asset class benchmarks, these ETFs are called “passively managed”. Cost is a key component of passive index investing – it needs to be as low as possible since there is no expectation of achieving additional returns beyond the benchmark index but they are expected to return as close to the returns of their respective index as possible. Since ETFs are a cost-effective and flexible way to gain index exposure, the rise in the use of indexing amongst the investing public coincided with the rise of ETF usage.
Although ETFs have traditionally been associated with passive indexing, this doesn’t mean they can’t be actively managed like a typical mutual fund using a portfolio management team to seek better risk-adjusted returns. In fact, ETFs are an excellent vehicle to offer actively managed investment strategies, which is why Horizons ETFs is one of the largest providers of actively managed ETFs in Canada. Our suite of actively managed ETFs offer the benefits of ETF investing, combined with the advantages of active management – which we believe offers the potential to deliver better risk-adjusted returns in many asset classes.
Unique Features of Actively Managed ETFs in Canada
A major reason that actively managed ETFs or “active ETFs” have been more successful in Canada than other developed ETF markets is due to the regulatory environment of the Canadian investment industry. The majority of active ETFs are regulated under National Instrument 81-102. This means that ETFs are governed under the same laws that govern most mutual funds.
In Canada, the disclosure for ETFs and mutual funds is generally the same. In the case of Horizons ETFs for example, the top 10-holdings of our actively managed ETFs are disclosed publicly on a monthly basis, our top-25 holdings are disclosed quarterly and our full portfolios are disclosed semi-annually. We view this as a suitable level of transparency.
A key feature of ETFs is their liquidity – as units can be bought and sold throughout the business day on an exchange. In order to ensure the units trade at (or very near) their current net asset value (“NAV”), an institutional capital markets trader, known as the “market maker”, holds an inventory of ETF units to facilitate their trading. The lead market maker acts to ensure the unit price at which the investor can buy or sell their ETF units, is close to the NAV of the ETF.
This process has worked well for actively managed ETFs, many of which now trade at bid/ask spreads equivalent to spreads observed on comparable index ETFs.
The Importance of Low Fund Management Fees
A central appeal of ETFs is their typically low management fees compared to regular mutual funds. Fees can have a significant impact on investment performance since they create an additional hurdle for the investment to overcome in order to be profitable. The higher the fee on an investment fund, the better the fund needs to perform to generate a higher return than its benchmark.
We believe the single-largest obstacle to the performance of Canadian actively managed mutual funds is high fees. The cost disparity between Canadian actively managed ETFs and Canadian actively managed mutual funds can often be dramatic. The cost savings on ETFs can potentially add significant value to the long-term returns of the fund.
Active management presents opportunities to help enhance returns and reduce risk through:
- Independent valuation analysis: Can conduct independent research on portfolio holdings, including cash flow analysis, risk analysis
and earnings forecasts.
- Institutional access: Fixed income managers generally obtain favourable execution costs for bonds.
- Not forced to buy/sell: Actively managed ETFs can opt-out of buying securities with questionable valuations or liquidity.
They are not forced to buy or sell issues blindly when an index rebalances.
- Independent credit analysis: With fixed income investing, active managers will undertake a full independent credit analysis of the underlying holdings of the portfolio. Credit analysis is a key determinant of the risk/return profile of fixed income investing and the likelihood of an issuer meeting its debt obligations.