More than 100 U.S. mutual fund companies have applied to the U.S. Securities and Exchange Commission to copy the ETF share class structure.Andrew Kelly/Reuters
Canada’s exchange-traded funds industry is preparing for an influx of new U.S.-listed ETF share class products they say could send more Canadian investment dollars flowing out of the country.
More than two decades ago, Vanguard Group received a patent that allowed it to launch ETF versions of its existing mutual funds – known as ETF share classes – and prohibited other U.S. mutual fund companies from doing the same.
The patent expired in 2023. To date, 104 U.S. mutual fund companies have applied to the Securities and Exchange Commission to copy the ETF share class structure. Ninety companies have been approved and four have launched ETF share classes, according to the Canadian ETF Association (CETFA).
Daniel Straus, managing director of ETFs and financial products research at National Bank of Canada Capital Markets, says that because of the massive scale of the U.S. market, U.S. ETF share classes – and standalone U.S. ETFs – can offer cheaper fees than their Canadian counterparts.
Canada’s ETF industry has been growing rapidly, with about $870-billion in net assets under management. But Canadians have also been investing heavily south of the border; according to CETFA, Canadian investors have about $300-billion invested in U.S.-listed ETFs.
Eli Yufest, CETFA’s executive director, says that as Canadian investors gain access to thousands of ETF share class versions, including some of the “most successful funds in the world,” investments in U.S. ETFs will likely increase.
He says Canadian ETF manufacturers still face structural issues that make their products less competitive relative to U.S. ETFs.
In a recent pre-budget submission to the House of Commons Finance Committee, CETFA called for the federal government to reform the “allocation to redeemers” tax framework introduced in the 2019 budget.
The framework prevents certain mutual fund trusts and ETFs from deferring capital gains taxes, as they previously could. U.S.-listed ETFs don’t have the same rules, Mr. Yufest says, offering tax advantages for investors.
He adds that Canadian investors holding U.S.-listed ETFs or securities directly in a registered savings account can avoid paying U.S. withholding tax under existing tax treaties between the two countries, but Canadian-domiciled ETFs investing in the same securities are hit with withholding taxes, which cut into distributions to investors.
Canadian ETF managers also have to charge sales tax on their management fee while U.S. managers don’t, Mr. Yufest says.
Rohit Mehta, president and chief executive officer of Global X Investments Canada Inc., says he thinks more investors today understand these tax differences.
“Investor knowledge overall has increased – there’s definitely more awareness than there used to be,” he says.
CETFA has proposed that the government launch a new registered account for Canadians earning less than $90,000 called the Maple Investing Tax-Free Savings Account, which would have a higher account limit for people who invest in Canadian-domiciled ETFs and a government-matching program up to $1,000 a year.
The case for buying Canadian
While cost and access to “celebrity” funds may draw in some curious investors, Mr. Straus points out there are still friction points for Canadians investing in U.S. funds and securities, including navigating U.S. estate tax rules and currency conversion.
Canadian ETFs that hold U.S. stocks are handling that conversion on behalf of their investors, and the cost differential between retail and institutional foreign exchange rates can amount to meaningful savings for investors, even accounting for the somewhat higher management expense ratio on a Canadian fund, Mr. Straus says.
However, in some cases, a U.S.-listed ETF can still be more attractive from a cost perspective, he adds.
Avinash D’Souza, vice-president of product strategy at Harvest Portfolios Group Inc., says the forthcoming wave of products raises due diligence concerns for advisors and investors around currency conversion, tax treatment in non-registered accounts, registered account efficiency and tax reporting complexity.
“For most Canadian client situations, Canadian-listed product still wins on those dimensions,” he says.
Advisors should also consider Canadian investors’ ability to get appropriate recourse if a U.S.-listed fund collapses, he says, or if there’s an incident of fraud. “It’s slightly murkier than with a Canadian-listed fund.”
Mr. Straus points out that with the forthcoming CRM3 total-cost reporting reforms, Canadian ETFs will have a “new level of transparency” in their disclosures, including a fund’s trading expense ratio, but “we’re not seeing similar kinds of new disclosure updates on the U.S. side.”
Mr. D’Souza says he believes the new U.S. funds will change the competitive landscape in Canada, “but probably less than headlines suggest.”
Many of the new products are well-known mutual fund strategies in a low-cost wrapper rather than net-new exposures that investors couldn’t previously get, he says.
Canadian issuers offering large-scale passive or active mutual fund strategies “face the most direct pressure,” he says, while asset managers with income-generation, yield and active option strategies – such as Harvest ETFs – “are competing on something that U.S. ETF share classes don’t seem to be focused on for now.”
Mr. Mehta says Global X is looking to its parent company Mirae Asset Global Investment Co. Ltd.’s U.S. ETFs business to “see where we can bring synergies.”
“We have great visibility into some of the product demand and trends in the U.S., and we can bring some of those into the Canadian marketplace or launch funds concurrently with our U.S. colleagues,” he says.