MARTIN LEFEBVRE
Hi everyone and welcome to our NBI podcast series. My name is Martin Lefebvre, Chief Investment Officer and strategist at National Bank Investments. Today I'm joined by Daniel Strauss, the head of National Bank Financials, ETF research and Strategy Group, whose focus is on providing both institutional and retail investors with value add and actionable investment research relating to exchange traded funds. Daniel, thanks for joining us today.
DANIEL STRAUSS
Pleasure to be here.
MARTIN LEFEBVRE
Daniel, let's start with your background. Could you tell us a little bit about your career and what drew a guy with a PhD in engineering to the ETF industry?
DANIEL STRAUSS
Sure, that’s a good question and it's one that I was well prepared to answer during the interview process when I was entering the financial services sector at the start of my career 12 years ago. I had only an academic background in engineering, particularly engineering, physics and nanotechnology. But I did take one year to do a Master of Finance program at the Schulich School of Business. The reason for this is when I defended my thesis in 2009 on the field of again nanotubes and infrared. Radiation, I noticed that the world seemed to be crumbling around me. There was the financial crisis, the great financial crisis was ongoing at the time and the job market seemed very shaky and uncertain. And I decided to myself, I in fact discovered quite forcefully, that obtaining knowledge in the world of finance would serve me very well. You know, it seemed incredibly important in the in the world that was emerging to me at the time. So, I took one year to study finance. To my delight, I discovered that it's all math and very similar to physics. I enjoyed it tremendously. And unlike science and math, within finance, you never really gain the answer definitively because there's no objective truth out there like the world of science in finance. Once you have a good model or something that works, the system incorporates that into its behavior and then these feedback loops, which are of course collective human behavior. The behavior going forward, making things very hard to predict, but it adds to a continual sense of excitement and that's why I kind of fell in love with it. I was very fortunate to arrive at this at the National Bank's growing ETF research desk around this time in 2010 and haven't looked back since.
MARTIN LEFEBVRE
OK, so you've been the head of the ETF research, as was mentioned, for some time now. And I guess like many investors, you've witnessed the industry boom over the past years. What struck you the most with the rise in ETFs in in Canada, Daniel?
DANIEL STRAUSS
Sure, so many striking observations. But I'll tell you one that occurred to me when I when I first landed on the desk here at the start of my career was that I saw that there were, you know, 100 and some ETFs in Canada with roughly 30, maybe 40 billion in assets under management at the time. We're talking about 12 years ago, I looked at this suite of available products, you know the bellwether passive index products that many people are familiar with, those that track the S&P 500 or the global aggregate Bond index. These or the TSX composite, and what have you, and I thought to myself, well, this is more than enough for any investor to make a holistic, well diversified portfolio out of these building blocks. Certainly, there won't be any need for more launches or new kinds of products. But I can tell you that even after 12 years, the pace of launch is still dizzying. There are well over 1200 ETFs in Canada now with roughly 300 billion in assets under management. That's 15 to 20% year over year cumulative. Average growth rate and the variety of ETFs doesn't cease to amaze me. There's every flavor of factor and combination of factors. There are themes and sectors galore of actively managed ETFs. The zoo and taxonomy of available products in the marketplace has truly, truly mushroomed every single year. I ask myself, is it going to plateau? Are we going to see a slowdown in the pace of launches and innovation? That hasn't happened, so that's why I still find it fascinating.
MARTIN LEFEBVRE
Daniel, just fact based. I mean, there's many, many launches year after year, as you mentioned. Is it true that probably the top ten still represents 90% of the AUM?
DANIEL STRAUSS
Well, that's definitely true. In the United States, where the top three have about 80% of the AUM and that would be in the United States. iShares Vanguard and State Street and in Canada too, there is a little bit of that going on as well. It's RBC and iShares. They have formed an alliance with their suites in Canada, Vanguard, BMO and then, in fourth place, Horizons that do have very significant portion of the market. But there are 42 some providers in Canada now. And what we are noticing is that there is something of a trickledown effect. There is a kind of flattening of the cumulative distribution amongst providers. Yes, it's still very top heavy, but just looking at product by product, for example, XIU is the largest and biggest and most liquid ETF and candidates also the oldest ETF in the world having launched in you know in the 90s when I started my career it was roughly 10 billion in AUM representing 25% of the market in one ETF. And now it's still roughly 10 billion in AUM. So, in a $300 billion market, there's been an enormous proliferation in hundreds if not thousands of other products.
MARTIN LEFEBVRE
OK. Interesting. Let's go back to the markets. As many other strategies you've been, you know, witnessing lots of volatility, not only in equity markets, but probably even more so in the fixed income markets. Have you witnessed in your research some strategies that have been resilient in these difficult times?
DANIEL STRAUSS
So that is a very difficult question to answer because uh, 2022 has been unique amongst the past several decades as being the worst for both the combination asset classes of stocks and fixed income. You know they're in the 2008 or 9 financial crisis, credit and equities certainly sold off, but long-term bonds made-up for it. And if you were in a diversified portfolio, you may have been able to withstand the volatility by hanging on, but this year we are seeing probably a perfect storm and the worst possible environment for let's say a 60/40 portfolio holding passively all stocks and all bonds. Very little has worked. That said, on a comparative basis, some strategies have worked a little bit better than others. The low volatility factor for instance is one that was very strongly favored in the aftermath of the financial crisis and had enormous assets behind it at the start of the COVID-19 pandemic. But because it didn't perform that well through the pandemic, many investors kind of soured to it in the 2020 and then 2021 recovery year. But now we are seeing that at least on the comparative basis, the low volatility factor is doing a little bit better than traditional passive strategies. But unfortunately, a lot of investors kind of gave up on it perhaps a bit too early. So that is one example and another one is and it's kind of painful to say so because it's very boring. It's cache in the world of fixed income. Umm, you know, Cash is typically seen as something that is very boring and unlikely to keep up with inflation. But in this era of rising rates, it's hard to compete with something that is very, very short in duration and paying out an increasingly attractive yield. And there are high interest savings ETFs which I've seen incredible growth in 2022 so far.
MARTIN LEFEBVRE
Yeah. In terms of flows, are there in the indication of what investors are doing in these times of a high inflation and rising rates, are they moving from, I don't know, passive to active or besides that low volatility, are there other strategies that you're you have witnessed?
DANIEL STRAUSS
Sure. So a great question and we are observing multiple currents at play that kind of overlap with one another. The first is the kind of long-term ongoing migration to ultra low-cost investing. I don't want to call it a migration from active to passive because it does definitely appear that way. We see large outflows from mainstream active strategies from the world of mutual funds and into ETFs, especially the ultra low-cost ETFs. And that does look like a rotation from the world of active into passive. And in fact, if you look at, for instance, global data or statistics gathered by BlackRock or Bloomberg, you'll see that now something like 40% of all professionally managed assets in the US, which includes mutual funds and ETFs and managed accounts and so on, 40% is passive, which is quite large and well up from the low single digits that it used to be even a decade or two ago. So, there is that migration going on. Even as markets are selling off and we're talking about the S&P 500 and the TSX Composite going down significantly, you know well into the double-digit percentage point declines, you still see inflows into the passive index products and that stands to reason because more most of people's assets are still held in single stock holdings or in passive mutual funds and people are selling those. That's in fact what causes markets to decline. It's a group behavior of most everybody selling almost everything. And when they find themselves holding freshly liberated cash, where do they put that cash in order to just get default exposure to the market? Increasingly, that's ultra low-cost passive ETFs. So even as the indices are selling off, we find flows going into those categories.
MARTIN LEFEBVRE
OK. You've mentioned there's been, you know, a lot of launches over the past years. But what what’s the next trend? What do you see taking off in the Canada in the Canadian ETF space in the years to come?
DANIEL STRAUSS
So, another good question. You mentioned inflation method and I think that that's something that is increasingly on the minds of many, many investors. I anticipate that there'll be a lot of new kinds of products that attempt to address that, but certainly within our network and on those who rely on the kind of economic commentary of our you know, chief strategist and our sale office, they’re looking at, you know, just Canadian equities. Canadian equities, for instance, have been, at least historically, one of the better inflation hedges out there because of our resource economy. So that is definitely one area where we're seeing inflows. But at the same time and perhaps in counterpoint to that, there is growing appetite for ESG. And I know you didn't ask about ESG specifically, but it is very much a growing area of interest amongst our clients. More and more questions coming up around ESG, many kinds of products being launched by a variety of providers taking their different spins on the concept. Some with ESG tilted indices, traditional indices that are modified with ESG screens or filters, or reweighting in addition to for instance, you know very active ESG mandates, which take concentrated bets on what an active manager would consider the best ESG actor. So, we are seeing a lot of innovation in that space as well.
MARTIN LEFEBVRE
Thank you, Daniel. Let’s shift towards advisors and investors. As you know, markets are down significantly whether it's Canadian equities, even more so in the US and even the bond market is down. So, is there any way for investors to harvest the tax loss in someone’s portfolio? And before answering that, could you just tell us a little bit about tax loss harvesting, what it is? What are the benefits?
DANIEL STRAUSS
Sure, sure. So, yes, I'm happy to answer this question, but before I do, I have to issue my kind of boilerplate disclaimer that we are ETF research analysts and very far from actual tax experts. So, because tax questions are very often complicated and very tailored to an individual's scenario, please consult with your resident tax expert or advisor to see how what we're about to talk about pertains to your portfolio specifically. And very often, there will be many opportunities to kind of what we call a tax loss harvesting trade. That is when you find yourself with certain loss positions in your portfolio, let's say a single stock that is declined by 20 or 30% and you have a significant position, you can sell that stock and crystallize the loss and the kind of capital gain credit that you would gain from recognizing this loss can be applied against capital gains in the current year carried back three years or carried forward indefinitely, sheltering future capital gains from other portions of your portfolio. And that is something that we found is a huge kind of value addition opportunity for advisors, investors, portfolio managers. In fact, the whole rise of this kind of buzzword direct indexing in the United States has to do with the opportunity to almost algorithmically search out tax loss harvesting opportunities and an individual investors portfolio. Essentially what is an SMA but with some kind of very computationally intense algorithm searching for these pair trades that you can do to recognize tax losses and ETFs naturally promise to be very amenable to these because especially if you hold a single stock that is down significantly, you can sell that stock. And so long as you do it correctly under certain parameters as recognized by the CRA, you can cycle into an ETF to maintain exposure. So, for instance, many people are reluctant to do this; a loss trade because they see if the stock has had a sudden decline this year or a major decline. They don't want to miss the opportunity, shall we say, for a quick recovery or a bounce, especially if the stock is very volatile, that can happen. And so, in order to kind of, let's say dull the regret that you might feel for the 30-day period when the stock recovers, if you move instead into an ETF that offers an approximate exposure rather than simply holding cash for the 30-day period to recognize the loss, you can gain some participation in the stocks recovery should it occur in that 30-day period. We published on this frequently. Towards the end of the year, we will identify the stocks and for instance, the S&P TSX composite that are listed on the Toronto Stock Exchange that have the most significant declines and that have pairwise appropriate ETFs, often tracking that sector of that stock to cycle into for 30 days. And we can get into precisely what are the best practices around a trade of that nature.
MARTIN LEFEBVRE
OK, perfect. I guess people can also rely on the paper you just wrote and we can publish a link as a follow up. Daniel, I can't let you go without asking you what you think about the NBI ETF series. We've launched a few over the past couple of years. Where do you feel we've been innovative in a very competitive space?
DANIEL STRAUSS
Sure. So yeah, I would say that you know, as ETF analysts, we are, you know, very encouraged to see so many new innovative providers come to market and that the ecosystem is flourishing, very competitive to the benefit of end investors. NBI is absolutely playing a part in that. I would say that they've very much staked a claim in the world of active ESG management. We have been extremely impressed, for instance, with their sustainable Canadian equity product. Even though it's in the sustainable space, we found that especially towards the start of the year 2022, many investors who had been very keen on the ESG concept at the start of the year found themselves a missing energy exposure and lagging. As a result, it was one of the few sectors at the start of 2022 especially that was doing well in this inflationary environment and when everything else was selling off, especially those high growth names which tend to be overweighted in other ESG indices. It makes perfect sense that technology and certain sectors like that would be overweight in a traditional ESG index tracking product, because companies like your software companies, cloud companies and so on don't have much of a physical footprint to begin with. And so, they tend to kind of through the back door screen well through ESG metrics. Other ESG products also are very similar to the index. And you know, I don't want to call them closet benchmarkers or closet indexers, but they may be very similar to the index as it is. One of the trends we’re finding that we're encouraged by in the world of ETF's more generally is the fact that ETF seem to be kind of signing the death certificate of closet indexing. You know, there was a big practice within the world of mutual funds and active management for a very long time. The largest products would charge very high fees for a portfolio that essentially looks very similar to the index with only minor differences. And this may even be true in the world of ESG. More factor investing or any other mandate that you wish to choose. So, by very transparently and openly concentrating into a high conviction ESG basket, you give ETF investors the opportunity to use the product as a satellite in addition to your low-cost passive core if that's what you wish to do. So that is something that we've been encouraged to see. It's a welcome innovation.
MARTIN LEFEBVRE
Excellent. Daniel, on closing, other than the ESG, you've already mentioned, what other opportunities or trends could investors be looking into next year?
DANIEL STRAUSS
So, there's so many things happen in the world of ETFs that are, you know, incredibly powerful tools. But at the same time, you know, with power tools, you can cut yourselves, right. So, we are in the game of educating clients around ETF. So, we don't want to tell people do this, don't do that, buy this or don't buy that instead. What we like to do is educate our clients with what is under the hood of the products that they're considering. And there are many more products coming out in the world of alternatives. As well as option-based strategies, things like put right strategies covered, call strategies and so on. So, we find that these products can be extremely powerful for instance covered calls are very useful for investors who want to extract additional yield from their stock portfolios at the cost of additional upside. But that's the key. If you don't understand that there is a cost of partial upside participation in a covered call strategy, you may be in for a surprise. In fact, we might find some people who wish to do, for instance, a tax loss harvesting trade in a particular sector that has had a decline and if there's a covered call ETF in that sector and they move into that ETF, for instance, to harvest the tax loss, they'll find that it runs very much counter to the principle of trying to catch an upward bounce in that stock. If that whole sector is on a strong uptrend, you'll find less upside participation. If there's a covered call overlay. So again, the world of alternatives. Very, very interesting developments happening there, I know. NBI has one there that's a very mathematically sophisticated and as a result has been doing exactly what you would want an alternative to do, which is to zig when the market zags and we're finding a lot of innovation and launches around that space because of liberalization around the use of alternatives and what's called the Alternative Mutual Fund regulatory regime in Canada. So that is something that we intend to monitor for a long time going forward, but again, it behooves investors to do the due diligence, understand how the product works. And that's why we sit here at our ETF research desk. Anybody who is curious about our particular category or even an individual ETF is welcome to get in touch with us and we will lift the hood and help educate. And map the clients’ goals and desires to the right product to use within a specific category.
MARTIN LEFEBVRE
Well, Daniel, this is all the time we have this morning. Thank you very much for sharing your thoughts with us. It's been a pleasure.
DANIEL STRAUSS
Thank you, Martin. And we also are looking forward to the next bits of research and economic analysis from the CIO Office as well.
MARTIN LEFEBVRE
Thanks again and everyone, thank you for tuning into this NBI podcast and, until next time. we will talk very shortly. Thank you very much.
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Martin Lefebvre
