I recently had the chance to speak to Jonathan Needham, Vice President & Director, Lead of ETF Distribution at TD (TSX:TD) (TSX:TD) Asset Management Inc. (TDAM)
I talked to him about popular Exchange-Traded Funds (ETFs) in Canada in 2023, the ETFs that may experience strong performance in 2024, and key secular trends for the year that Canadian investors might want to reposition for.
Ketki Saxena: Hi Jonathan, great to speakß with you again. Thank you for joining me today.
Jonathan Needham: My pleasure. Thanks for having me.
Ketki Saxena: Let’s just dive right in. I wanted to start by asking about what's been one of the most popular types of ETFs in Canada last year: fixed income. Specifically, money market or cash like ETFs. So, I wanted to ask, what have been the drivers of the recent inflows and the popularity of these fixed income ETFs?
Jonathan Needham: Plain and simple: first, yields appear to be attractive again. You can get yields on cash of around 5% with little risk.
The second thing: during the interest rate hiking cycle, there was a lot of fear about a hard landing, or a recession, in the economy. As a result, markets were volatile and investors were looking for safety. Of course, in hindsight, this is a year where equity markets climbed the wall of worry and cash significantly underperformed equities.
That’s the downfall of trying to time the market, but the upshot is that there was record growth for money market ETFs and investors earned an attractive yield relative to the previous few years.
Ketki Saxena: Now that we're coming to a time where central banks are expected to pivot to lowering interest rates in the coming months, do you expect inflows to fixed income and cash-like ETFs to continue at a similar pace. For a retail investor, should this type of ETF remain a key part of their portfolio?
Jonathan Needham: I think the short answer is no, you're not going to see the same inflows we saw last year, not into cash. We have already seen this reflected in year-to-date numbers.
Perhaps fixed income ETFs that have a longer duration than cash proxies will see increased inflows. What we have seen is strong cash inflows into equities: U.S., international and to a lesser extent Canadian.
However, I would argue that cash still plays a vital role in a portfolio. It can be used as an emergency fund for any type of short-term goal or purchase. And of course, it never hurts to have a little of what we call “dry powder” in the industry. The ability to put money to work if the market surprises you to the downside.
It's a great time for bonds again with attractive coupons and yields and some capital gain potential if interest rates start to decline. For example, a passive aggregate bond market ETF like TD Canadian Aggregate Bond Index ETF (TDB), which has about a seven-year duration, is giving you a coupon of about three percent.
So if rates drop by 1%, you may get an additional 7% of return, and that’s about a 10% total return from a fixed income product that invests in investment grade and high quality bonds. You're also getting some capital appreciation that is tax efficient.
Ketki Saxena: I remember the last time we'd spoken you talked about bonds being one of the big stories and so we did see that, playing out.
Jonathan Needham: I was a little early. We didn't see it play out until the last quarter of last year, but bonds ended in positive territory last year.
Ketki Saxena: So just to touch a little bit on the cash component in a portfolio. Typically, this has come, as you mentioned, at the expense of portfolio returns. Is there a way investors can mitigate this risk and still diversify their portfolio?
Jonathan Needham: I’ll use the example of one of our ETFs, TD Cash Management ETF (TCSH), here. It's an ETF that invests in fixed income securities - call it a money market alternative, with a duration of less than 90 days.
In the last couple years, because of the regulatory environment and the way in which they treat deposit products - or high yield investment savings accounts (HISA) in particular - those yields have dropped relative to money markets funds and ETFs and relative to a product like TCSH.
Today you can get a better yield, taking on a similar amount of risk, with low fees and full liquidity. So, if you are going to add a cash component to your portfolio, which most people do, a product like TCSH or similar may be a great solution.
Ketki Saxena: So, thanks for that little recap of the most popular ETF in 2023. In 2024 so far, Bitcoin ETFs have been all the rage. Since they were approved in January by the Securities and Exchange Commission, there's been roughly 12 billion of net inflows and 60 billion in assets.
Why do you think they’ve become so popular? What benefits do you think a Bitcoin ETF (TSX:EBIT) offers retail investors, relative to investing directly in BTC?
Jonathan Needham: Yeah, let's cover both. Let's be honest. I think the Bitcoin ETF launch south of the border may be the most successful launch in ETF history. Pretty remarkable how quickly they gathered assets.
In terms of why an ETF vs Bitcoin itself - it's much easier to buy and sell an ETF than Bitcoin, at least for most investors. Liquidity is ample, and easy to access through any online brokerage account or of course through a full-service advisor, and the cost of entry and execution is low.
When it comes to considering Bitcoin, it is still a very speculative investment and highly correlated to tech stocks - so not really the diversifier that many were hoping for. But I can't argue with the fact that it's been a store of value. It has performed exceptionally, in particular last year and so far this year.
Ketki Saxena: Apart from Bitcoin ETFs, another popular theme this year has been ETFs focused on exposure to the Magnificent Seven. So, there's immense focus on this, but should investors be broadening their horizons beyond the mega-caps? Maybe even looking at mid or small-caps?
Jonathan Needham: I think the first thing to keep in mind is that the U.S. is still a core market to own and a difficult one to beat. That's been emphasized with the Magnificent Seven driving performance, particularly last year.
The good news this year is that the gains have broadened out to the other 493 stocks. So, you can get that through any ETF that tracks the U.S. broad market like the S&P 500 Index.
An alternative I really like is TD U.S. Equity Index ETF (TPU). TPU tracks similar stocks to those in the S&P 500. However, its methodology incorporates some of these tech/growth stocks faster than the S&P 500. There’s also TD Global Technology Leaders Index ETF (TSX:TEC) which is our flagship technology fund. It's global in nature and has provided investors with solid returns and is a diversified, prudent way to access tech stocks and the theme of Artificial Intelligence.
I think now you're starting to see this market broaden out, and there's a lot of other names trading at very attractive valuations relative to historical norms. And that would be in small and mid-cap stocks.
With these stocks you're getting better diversification of sectors and industries, and you're getting attractive price points.
For example, TD Q U.S. Small-Mid-Cap Equity ETF (TQSM), our small-mid-cap ETF has done exceptionally well. And I would argue it has very attractive valuations in the underlying securities as opposed to the Magnificent Seven and the broader U.S. market.
Ketki Saxena: You've identified this broadening of gains beyond the Magnificent Seven as one of the key trends that we're seeing already in 2024, and the benefit of exposure to small and mid-cap stocks. As you were so spot on in your predictions the last time we spoke, I want to ask what you think will be other key trends this year.
Jonathan Needham: Quality is something you really want to look at. We're still in an environment in which there's risks and volatility. So, you want quality companies: strong balance sheets and future cash flows. You want profitable businesses that have secular trends behind them.
In that scenario, we have a couple strategies that I would argue would stand the test of time, our enhanced dividend strategies: TD Active Global Enhanced Dividend ETF (TGED) and TD Active U.S. Enhanced Dividend ETF (TUED).
They're both focused on dividend payers and take advantage of secular trends. We also have an options overlay strategy to help enhance the yield and protect a little bit on the downside.
Jonathan Needham: There’s also TD Q Canadian Dividend ETF (TQCD) for Canadian dividend exposure and TD Q Global Dividend ETF (TQGD) for global dividend exposure. These products have a very disciplined quantitative methodology that allows us to isolate for companies likely to continue to grow their dividends, pay attractive yields, and those that have strong balance sheets and cash flows.
My final thought is that commodities are a great diversifier - they've underperformed for the last number of years. A perfect example is gold and we're starting to see value in other commodities like oil and agriculture.
Ketki Saxena: Thanks Jon, I look forward to looping back on this in a year! Do you have any final thoughts?
Jonathan Needham: I think the final thing would be just don't forget about bonds. We all want to have a balanced portfolio. Bonds albeit have not been great performers in the past few years but they are a ballast to equity volatility. And today they look very attractive from a risk return perspective. A
I would encourage investors to get back to their balanced weight between cash, fixed income, and equities, and that likely means taking some profits from equities and redeploying into bonds.
Ketki Saxena: Thank you Jonathan for those words of wisdom.
Jon Needham: Thanks Ketki for having me. Great to chat again.