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Why fund managers are embracing ETFs

INVESTMENT FUNDS REPORTER

Exchange-traded funds (ETFs) are supposed to be the boring, low-rent enemies of money managers.

But some managers, whose job it is to try to pick the stocks or sectors that will outperform a benchmark, have become fans of the ETFs designed to passively mimic an index or commodity moves. And now they are scooping up those ETFs, which trade like stocks, for their own funds.

Brent Smith has been sprinkling ETFs in the Quotential mutual fund portfolios that he runs at Franklin Templeton Investments Corp. because he sees them as a tool to let him shift his asset mix quickly instead of just buying and selling his firm's mutual funds.

For Mr. Smith, being able to invest up to 10 per cent of a fund in ETFs since last fall has been a blessing. In the past, a decision to sell $100-million in a Franklin Templeton fund quickly might be delicate. He would have to alert the fund manager, who in turn would have the headache of raising $100-million in cash. That could take more than a couple of days, and have tax implications for the unitholders.

"With ETFs, it can be done in a day," says Mr. Smith who takes a tactical approach in co-managing the $7.5-billion Quotential fund-of-funds program. "If I want to go from equities to fixed income, I can just sell one of my equity ETFs and buy a bond ETF."

More fund managers are embracing ETFs as these easy-to-use, low-fee funds proliferate. "I see a broader array of products being used, but that is because the universe of products has expanded so rapidly," said Dan Hallett, director of asset management at HighView Financial Group.

ETFs are more commonly used by managers with a "top-down" investment style that relies on a set of assumptions about the economy to drive investment into and out of sectors. Fund managers will also invest in ETFs for reasons ranging from cash management to easy exposure to markets or commodities and hedging strategies.

Morningstar Canada's direct ownership data reveal that the number of Canadian ETFs held by mutual funds has been growing recently, analyst Esko Mickels said. "By far the most popular Canadian ETF among mutual funds is iShares S&P/TSX 60 ETF."

Managers may hold an ETF temporarily in lieu of cash to get market exposure until they find securities they want to buy, or until they can later buy back securities sold for tax-loss selling reasons, he said. "If they [managers] are looking for market-like returns, it usually makes a lot of sense ... A lot of the larger bank funds might do things like that."

Peter Mennie, a manager with MFC Global Investment Management, uses ETFs to manage smaller cash amounts coming into his Manulife Emerging Markets Fund. "If the inflow starts to accumulate to a reasonable size, it can be deployed efficiently into individual stocks," he said.

His latest top 10 holdings includes the iShares MSCI Thailand, iShares MSCI Taiwan, iShares MSCI Turkey and iShares Emerging Markets ETFs. These passively-run funds can provide easy access to countries where brokerage costs can be expensive or to markets that are "less liquid," he said.

Manmeet Bhatia, a manager with QTrade Fund Management, invests only in ETFs in his QFM Global Equity and QFM Global Sector Target funds even though he can buy stocks or other mutual funds.

For instance, his $9-million QFM Global Equity owns ETFs ranging from iShares CDN MSCI EAFE to Vanguard Emerging Markets and iShares FTSE Xinhua China ETF. "They provide an efficient way to get exposure to markets for us especially if you are a small, growing fund," he said.

Mr. Hallett sees many funds holding the U.S.-listed SPDR Gold ETF these days. It was the top holding at 5 per cent recently in BMO Guardian Global Absolute Return. "They [managers] view it as a more convenient way to get bullion exposure versus buying bullion and paying storage," Mr. Hallett said.

© 2007 The Globe and Mail. All rights reserved.

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