Where has money been flowing in ETFs amid recent volatility?

It's been an interesting summer in the markets-- a sector rotation and a brief but dramatic selloff. So what has this meant for fund flows in the ETF space? Joining us now to discuss is Andres Rincon, managing director and head of ETF Sales and Strategy at TD Securities. Andres, it's always great to have you on the show.

Thank you for having me.

Usually, summers can be sleepy. It's been an interesting summer with your half year report as well about what's happening in ETF versus mutual fund land. What did you find?

Well, what we can clearly see is a continuation of a trend where ETFs are dominating. And ETFs continue to be the driving force of flows in the fund industry in Canada and in the US. And also, to your comment earlier, they're also very much in a risk-on environment, which is really, really interesting, given all the volatility that we're seeing as of late.

And just to give you some perspective, in ETF land, we've seen about $33 billion in inflows this year. And mutual funds have outflows of $8 billion this year. And this is a trend that we've seen since COVID, really. In Canada, COVID was the turning point. In the US, that turning point happened many, many more years before.

But we don't really see a way back where mutual funds actively and consistently bring in more inflows than ETFs. And what's really interesting is the mix. So you're seeing inflows in fixed income across both vehicles-- mutual funds and ETFs.

And mutual funds are seeing most of their inflows, or outflows, really, in equity ETFs. And, really, the big chunk of it is in balance ETFs. And we believe a big part of that is interest rates, obviously. So if you have interest rates that are high, people would want to be in yielding products instead of being in their balanced portfolios. Now, with rates going the other way, perhaps we see a little bit of a shift back into mutual funds on the balance side. But for now, mutual funds are seeing a lot of outflows in the balance side and the equity side, while both vehicles are seeing a lot of inflows-- obviously, in the case of ETFs, across all products, but also very strong in the fixed income side.

So it's very, very interesting. And also really interesting to see is that the ETF side is a little bit lagging when it comes to fixed income compared to mutual funds, in that there's still a lot more money going into mutual funds when it comes to fixed income. But, as we've seen the trend over the last few years, ETFs are starting to dominate.

You mentioned balance funds there. As I was going through the report, and I don't know if I got this right or not, it seemed like people were not as interested in balance funds as they were-- rather just getting into fixed income themselves or getting into equity themselves.

Yeah. And many of these same investors are actually switching out of the mutual fund balance fund into the balance fund on the ETF side. So what we call the asset allocation ETFs are very popular here in Canada. They're traded very, very heavily by retail and they are, in fact, very popular.

But you're right, a lot of investors are choosing to pick their own tools. And they're buying the equity ETF or the fixed income ETFs separately, and they're building their own portfolios using ETFs.

All right. Fascinating stuff. Covered call ETFs-- we've talked about them with you before on the show. You say that space is going to heat up in terms of competition.

Yeah-- not just covered calls. For starters, if we step back, we have-- in number, we have 40 issuers here in Canada, which is a significant number. But we've seen a slowdown in new entrants from Canada into the Canadian market. Now we're seeing a couple of new interesting entrants from the US. And obviously, the US has many, many large issuers that are not necessarily in Canada today.

Obviously, we have some large ones already here, but many of the US issuers are not here. So most recently, we had filings from two very large asset managers in the US that are coming into Canada. They've already filed. One of them is JP Morgan Asset Management, which is the largest active manager in the US, or one of the largest.

And you also have Capital Group, which is, obviously, a very big equity and fixed income player in the US, too. Most notably, in the case of JP Morgan, they're coming in with two of their most popular products in the US. So the two largest covered call funds in the world are managed by JP Morgan. This is JP and JPQ.

These two funds basically give you exposure to the broad market, be it the S&P 500 or the NASDAQ, in an active portfolio and doing covered call writing. These funds-- like JP is $33 billion in the US. JPQ is $15 billion in the US. And these funds are now being brought here to Canada.

So it's very interesting. Now, what we're seeing now is many of the other players now entering the market in covered calls. So you have Fidelity just filed, which they've never had one. Invesco just launched today. They launched two income advantage ETFs, which are basically covered call ETFs. And it's the first ETFs in Canada that use ELNs for their yield from a covered call perspective-- ELNs are equity-linked notes.

So, like, a new generation of covered calls?

Yes. In the US, they're a little more common. The JP and JPQ in the US use ELNs. It's a different structure in the US, and it favors the US market, which is why they're used a lot more in the US. And now they're bringing them here to Canada. So it's exciting. And there's a lot of issuers now coming with these products here to Canada.

Right. So maybe some investors watching the show are going to start taking a look at these products, doing some research. What would the risks be in a product like this?

For sure. So the risks-- at the end of the day, people have to remember that when you have a covered call fund, they're still along a basket of stocks. So there's still downside exposure. They do provide some yield back to the investor that can buffer some of your downside exposure. But at the end of the day, you're still along a basket of securities that will have some volatility. So it's important to understand that.

It's also important to understand that you're giving up upside. So there's an opportunity cost when you're selling calls, when you're generating yield. The investor is making an active decision to move away from growth into yield.

So because they're giving away that growth, you are giving up that opportunity cost, or the opportunity cost is there. So that's very important to understand when you have, obviously, ETFs or investing in that space.

Always fascinating stuff in that space. Regular viewers of this program are going to know that Andres also has his own show called Buyside Views, where he interviews prominent voices in the finance industry. In his most recent episode, he was joined by Tim Wiggan, who is the group head of Wealth Management and Insurance at TD Bank Group. They discussed the big trends that he's focused on in wealth.

The first off is demographics. I've always been fascinated in studying demographics and the impact it has on capital markets generally. So we obviously have an aging demographics, and that's creating all sorts of factors and themes in the business. One of the major ones is, obviously, the move from accumulation to decumulation.

And I like to think of that as converting your assets into income. You stop working, and you're basically using your savings and investment dollars to create an income stream for you. Demographics, as well, has a part to play with the younger demographic. They might have a different set of principles as it relates to the financial institution that they choose to deal with. They may not want to deal with the bank that mom and dad have. And so that's a major factor.

Interesting points there on how demographics can change the investment landscape. They also discuss how high interest rates have impacted the wealth business.

High interest rates can affect things like investment allocation versus savings allocation. So with a very high level of interest, it might dissuade someone, I think to their detriment, but might dissuade someone from starting the investment journey relative to just having savings, which may not be as efficient from a long-term return perspective and a tax perspective, but is obviously part of the package.

Lots of interesting stuff there, Andres. And I know that was just like two little threads of a really fascinating interview that I had a chance to check out as well. What else stood out to you from that chat?

Look, first thing that stood out is how interconnected all the businesses are that Tim works on. And it's very important to leverage all the businesses to service the end clients. And the end clients can be anywhere from retail to family offices, and, obviously, institutional clients in his world. So it's very interesting how all these businesses are interconnected.

He also talked about insurance, which is a very interesting area right now with all the natural disasters that are happening, and auto theft and all the different areas. So that was fascinating for me to really listen to. And also, the growth of wealth-- how it's really being diversified globally and how it's changing quite rapidly.

So Tim and I go a long way. We both worked on the trading floor for quite some time.

He has a history in TD Securities, doesn't he?

Yes, he worked a row away from me for many, many years. He was in equity sales a long time ago. And then he did many roles in banking and capital markets.

So he has a wealth of experience. And I do encourage, obviously, your DI audience to log on to the TD Securities website, listen to the video, and they can also listen to it on Spotify and Apple Podcasts, because it's really fascinating what he has to say about the growth of the wealth industry.

[MUSIC PLAYING]