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Canadian ETFs To Harness Long-Term Secular Trends: Interview with Jonathan Needham

By Ketki SaxenaETFsDec 08, 2023 16:03
Canadian ETFs To Harness Long-Term Secular Trends: Interview with Jonathan Needham
By Ketki Saxena   |  Dec 08, 2023 16:03
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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).

We discussed the surging popularity of exchange-traded funds (ETFs) in Canada, a range of Canadian ETFs to consider to capitalize on long-term trends, and whether USD or CAD-denominated ETFs are best for Canadian investors.

What's driving the popularity of ETFs in Canada?

Ketki Saxena: Hi Jonathan, thanks for being here today. Shall we dive in?

Jonathan Needham: Great to be here, Ketki. Let's do it.

Ketki Saxena: So Jonathan, one of the things that I want to touch on first is the growing popularity of ETF assets in Canada. What do you think is driving the adoption of ETFs versus mutual funds in Canada?

Jonathan Needham: If you look at cash flows, the amount of money that has come into ETFs this year is almost equal to the amount of money that's gone out of mutual funds—about 30 billion dollars. This speaks to the popularity of the product among end investors and advisors.

There are a few reasons why ETFs are becoming more popular not just in Canada, but globally. I think first of all, flexibility. It's really easy for an investor to get in and out of ETFs quickly and effectively.

The second is transparency. You know exactly what you own, as most ETFs publish their holdings on a daily basis. Another reason is that you get instant diversification with a single ticket. Diversification is key to driving sustainable long-term returns and is the only free lunch in investing.

Third, costs and ease of use. ETFs can be purchased on your own through a direct investing account or a financial advisor. There are lots of resources you can use when researching ETFs or if this sounds too daunting, you can employ the services of a financial advisor who can help build a portfolio for you. It also doesn't hurt that an ETF on average has a lower management fee than a traditional mutual fund. The less we charge as an asset management firm, the more of the returns you get to keep.

We've seen massive adoption of ETFs on the advisory side as they continue to go fee-based. Direct investing clients have increased their usage of ETFs over the past few years. Investors today are more educated and have gravitated toward ETFs because of their flexibility, cost advantage, and diversification benefits.

Ketki Saxena: So those are a lot of the fundamental benefits of ETFs, which are definitely attractive to investors. What do you think are some of the macro drivers that have driven growth in ETFs recently?

Jonathan Needham: I certainly think there are multiple macro drivers. You're seeing increased adoption by the younger generation, particularly Milllenials and Gen Zs. The rise of influencers and social media have played a large role in this, and arguably gamification of the markets. But I think it just comes down to ease of use. Opening a direct investing account has never been easier, and the younger generation is more technologically adept. Plus, you don't need much money to get started.

The rise of active investing is another key driver. In Canada, we're seeing about 30 cents of every dollar go into active ETFs, so asset managers are launching their active strategies in an ETF wrapper, particularly south of the border where franchises in the multi-billions are moving from funds to ETFs for all the reasons I mentioned previously.

Currency effects

Ketki Saxena: Nowadays, there’s pretty much an ETF out there for any theme you want exposure to. And adding to this range of options, some of these ETFs - such as those offered by TDAM - come in both USD and CAD or hedged and unhedged versions. What are the advantages and disadvantages of each?

Jonathan Needham: We used to say there's an app for that. Now I can say there's an ETF for that. Any type of exposure you want, you can now get it through an ETF. When it comes to currency, it tends to be more of an investor preference.

For example, many Canadians have vacation homes in the southern U.S. and so they consume and spend in U.S. dollars. Those clients are going to continue to own U.S. dollar investments. If you're spending U.S. dollars, you want a certain amount of your portfolio in the same currency, to avoid conversion costs. That's one of the reasons why Canadian fund manufacturers make sure they have U.S. dollar investment options available on certain products.

I won't get into specifics, but for a Canadian investor that has a U.S. dollar Canadian domiciled ETF, there are certain tax advantages. A Canadian investor who owns an ETF listed on a U.S. exchange may have to report assets held to the Canada Revenue Agency depending on the dollar amount as it is considered foreign property. A Canadian investor holding a Canadian-domiciled ETF that invests in U.S. securities is not subject to this rule. In addition, Canadian investors who own U.S. listed ETFs may fall under the U.S. estate tax regime which could lead to a tax liability depending on their situation.

Now when it comes to hedging or not hedging, here's the thing. If the Canadian dollar strengthens relative to the U.S. dollar, a Canadian-domiciled ETF with U.S. securities would experience a return drag because of foreign exchange. Similarly, if the Canadian dollar weakens, the same ETF would experience an increase in returns, all else being equal. To limit this foreign currency risk, some ETFs are offered in both unhedged and hedged versions giving you options with little to no additional cost. What I usually tell investors is, if you are not sure on the direction of the currency, split the trade. In this type of scenario, having half in hedged and the other half in unhedged may be the safer bet, and a lot of retail investors do in fact do this. On the advisory side, they tend to follow their firm's currency outlook.

ETFs for exposure to long-term secular trends

Ketki Saxena: I want to talk a little bit about themes in the market Jonathan, and touch on recent research from BlackRock (NYSE:BLK) (NYSE:BLK). BlackRock talks about certain themes that investors are trying to increase their exposure to, for example AI or tech innovation.

BlackRock recommends ETFs as a vehicle to get this exposure because many people, when they're looking at AI for example, just focus on the Magnificent Seven, but that actually gives them limited exposure to AI innovation. What ETF would you recommend for exposure to AI, and tech innovation?

Jonathan Needham: The obvious one for me is the TD Global Technology Leaders Index ETF (TSX:TEC).

The reality is those mega caps, the Magnificient Seven as you pointed out, are going to be the leaders in AI. These companies have significant research and development budgets, high levels of data, and innovative products that can best utilize this powerful technology. So I would argue that the best exposure actually is probably a market-cap weighted ETF with those mega-cap holdings.

If you're a little nervous about having too much exposure to the mega-caps through your existing holdings, then you're going to want to diversify away from the Magnificent Seven. You may want to consider something like the TD Global Technology Innovators Index ETF (TSX:TECI). With this fund, you're going to get some exposure to the future Apples or Googles of the world. More of the innovators in the technology space while eliminating the mega-cap technology stocks that dominate certain indices. For instance, you'll get some cybersecurity, semiconductor, e-commerce, and cloud computing stocks.

And then finally, another product that I really like: our enhanced dividend ETF suite. TD Active Global Enhanced Dividend ETF (TSX:TGED) for global equity exposure and TD Active U.S. Enhanced Dividend ETF (TSX:TUED) for U.S. equity exposure.

While not pure play technology funds, they are actively managed and may include holdings that are exposed to secular trends like AI. The portfolio manager will look for companies that 1) are quality companies with strong growth potential 2) have strong balance sheets and 3) have underestimated future cash flows. Furthermore, the portfolio manager may use options, like calls and puts, to help enhance income.

Ketki Saxena: I also wanted to touch on another theme: healthcare innovation, which was mentioned as a key trend in 2024 by the same research from BlackRock. What are your thoughts on having exposure to the sector?

Jonathan Needham: A couple of things about the healthcare space first off as a sector. It's the second-best performing sector over multi-decades. Looking ahead, not only do you have long-term secular trends like an aging demographic, massive innovation, and strong demand for healthcare services, but healthcare today is actually very attractive from a valuation perspective. Healthcare stocks are relatively inexpensive particularly when compared to the broad market and tech.

Given these reasons, it should be a holding for most Canadian investors. However, the reality is that the sector is underrepresented in most portfolios since there are very few healthcare stocks in Canada. And Canadians tend to have a home bias.

In terms of ETFs, I really like the TD Global Healthcare Leaders Index ETF (TSX:TDOC). It's a great way to get exposure to healthcare and the growing trends within healthcare. And TDOC does that in a single ticket solution. With TDOC you're also limiting your exposure to the mega-cap pharma companies and you're getting more exposure to some of the more large and mid-cap companies that are going to be the next leaders and have less risk of patents expiring for instance.

Ketki Saxena: Jonathan I want to ask, what do you see as the trending themes next year?

Jonathan Needham: In the short-term, I think bonds are going to be exciting going into next year. They are offering very attractive yields and we're starting to see inflation come down which may put downward pressure on interest rates, which means opportunity for capital gains as bond prices move inversely with interest rates. This is why owning a bond ETF like TD Canadian Aggregate Bond Index ETF (TSX:TDB), which is representative of the investment grade bond market in Canada, may benefit your portfolio. Currently, you get an attractive yield to maturity of around 4.8% with the added potential for growth. You could see double digit returns if interest rates start to drop next year.

In the equity space I would recommend a focus on quality. If you're trying to manage tail risk, the risk of a downturn in markets, as some are predicting, something like TD Q Canadian Low Volatility ETF (TSX:TCLV) may help stabilize your portfolio and potentially outperform the broader market due to its defensive nature. Companies with strong balance sheets, consistent cash flows, and growing dividends also fit that quality measure. TD Q Canadian Dividend ETF (TSX:TQCD) and TD Q Global Dividend ETF (TSX:TQGD) are two additional options. They use a factor-based approach to identify companies that are paying consistent and growing dividends over time.

The final one I want to mention, another one of my favorites, is TD Q U.S. Small-Mid-Cap Equity ETF (TSX:TQSM). First, phenomenal returns relative to its benchmark. Second, investors are underweight small and mid-cap equities relative to the broad market that is tech heavy and concentrated to a few names. TQSM gives you broad equity diversification and valuations that are at steep discounts relative to historical norms. I would argue you're not going to be able to do it on your own by picking stocks in the small or mid-cap space. This is an area where an experienced portfolio manager can add value.

Any final words of wisdom or advice?

Ketki Saxena: Thank you so much Jonathan. Those were all the questions that I had for you, but I wanted to ask if you had any words of wisdom or guidance to share about ETFs?

Jonathan Needham: I think first and foremost, not all ETFs are created equal. So look under the hood at what the underlying holdings are, and the strategies employed. Returns and yields don’t tell the whole story, so be prudent. The good news is that many ETF providers publish their holdings on a daily basis. Do your research and if you have more complex life situations seek out the services of a financial advisor or investment professional. You also want to make sure you're with a trusted provider, one who has a diverse and experienced portfolio management team with a risk management focus and a strong performance track record.

Ketki Saxena: Thank you, Jonathan, for your insights today.

Jonathan Needham: Thanks Ketki, greatly appreciate it.

For more information about TD ETFs, please visit

Canadian ETFs To Harness Long-Term Secular Trends: Interview with Jonathan Needham

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Canadian ETFs To Harness Long-Term Secular Trends: Interview with Jonathan Needham

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