What the new CIBC Avantis ETFs mean for Canadians

Canada has recently introduced a new suite of Exchange Traded Funds (ETFs) from Avantis, offered through CIBC, which could significantly alter how many Canadian investors construct their portfolios. These ETFs incorporate the benefits of traditional index funds, such as low fees, minimal turnover, and broad diversification, while also implementing evidence-based adjustments designed to enhance expected returns. These are not what the presenter refers to as "ETF slop," and he aims to explain why they represent an interesting development for Canadian investors, though he stresses they are not for everyone and low-cost index funds remain a sound choice for most. The presenter, Ben Felix, Chief Investment Officer at PWL Capital, clarifies that this video is not sponsored and he has no financial relationship with CIBC or Avantis. The discussion begins by addressing the prevalent issue in the Canadian fund market: over 80% of funds are still old-school actively managed funds, based on year-end 2024 data. Active management is generally a losing proposition, with active managers rarely outperforming the market, especially over longer periods. This means a significant majority of Canadian investors are paying over 1% in fees, often to major Canadian banks, likely to underperform the market. In contrast, low-cost index funds, which have been gaining market share since their inception in 1976, simply replicate an index, keeping costs low and capturing broad market returns without attempting to beat the market. Index funds benefit from market efficiency, which is maintained by active managers' analytical efforts, even if those efforts don't yield excess returns for their investors after fees. However, index funds, while a substantial improvement over traditional active management, are not without their imperfections. Many track a market capitalization-weighted index, meaning they hold more weight in the largest stocks and less in the smallest. While owning the market provides exposure to the equity risk premium, which has historically delivered solid long-term returns, financial economics has identified other return premiums that typical cap-weighted index funds do not capture. The same theoretical principles explaining why stocks should outperform bonds also suggest that certain types of stocks should outperform others. By tilting a portfolio towards these specific stock types, investors can potentially capture higher expected returns, a concept supported by theory and empirical data, as highlighted in the 1993 Fama-French paper on common risk factors. Another issue with index funds is their systematic trading due to index changes, such as initial public offerings (IPOs) or changes in company stock issuance/buybacks. Research suggests this mechanical trading by index funds to match market composition changes results in an implicit cost of approximately 0.5% per year, which often exceeds their stated fees. The idea of constructing a portfolio that improves upon indexing, by capturing multiple return premiums and being intentional about implementation, might sound like active management. However, this approach differs from stock picking or market timing. It's a more advanced version of the principles behind market cap-weighted index funds, resulting in low-cost, broadly diversified portfolios that aim to capture multiple return premiums. Dimensional Fund Advisors has been a leader in this space since 1981, but their funds are largely inaccessible to Canadian retail investors. While Dimensional launched publicly available ETFs in the U.S. in 2020, they did not do so in Canada. This left Canadian investors without financial advisors at a disadvantage, often resorting to complex model portfolios involving multiple ETFs, currency conversions, and foreign withholding tax considerations. The good news is that Avantis Investors, founded in 2019 by former Dimensional employees, has now launched Canadian-listed ETFs, including a single-ticker asset allocation ETF. Avantis, operating within American Century Investments, shares a similar philosophy with Dimensional, focusing on evidence-based investing. The Canadian-listed products eliminate the need for currency conversion, avoid double withholding tax issues for foreign stocks in various account types, and offer international funds that specifically carve out Canadian allocation. This provides Canadian investors with a hassle-free way to implement this investment strategy without relying on U.S.-listed funds. The Avantis funds are not index funds because they do not mechanically track an index. They address concerns about index inclusion by not automatically investing in newly listed IPOs. Avantis will include newly listed companies only if sufficient financial information is available and the company trades at an attractive price relative to its financials, thus avoiding mechanical price increases following index inclusion. The core principle behind these Avantis ETFs is to systematically tilt portfolios towards smaller, cheaper, and more profitable stocks relative to their benchmarks. The aggressiveness of this tilt varies by fund, impacting expected returns and tracking error (performance difference from the index). While aggressive tilts can lead to higher expected returns, they also mean greater performance divergence from the market, which can be challenging for investors during periods when these tilts underperform, as has been seen in the U.S. market recently with the strong performance of mega-cap growth stocks. The presenter then details several Avantis CIBC ETFs: * **CACE (Canadian Equity ETF):** Management fee 0.19%. A Canadian total market fund moderately tilted towards higher expected return stocks, resulting in a lower average market capitalization, higher average book-to-market ratio, and higher average profits-to-book ratio compared to the cap-weighted index. * **CALV (US Large Cap Value ETF):** Management fee 0.25%. Focuses on large-cap stocks but tilts towards smaller, cheaper, and more profitable large caps, excluding small stocks and high-priced stocks. Its U.S.-listed equivalent, AVLV, has outperformed the U.S. market since its September 2021 launch. * **CAUS (US All Cap Equity ETF):** Management fee 0.19%. A U.S. total market fund with moderate tilts towards cheaper and more profitable stocks, offering total U.S. market exposure without excessive tracking error. Its U.S.-listed equivalent has outperformed the U.S. market since September 2019. * **CAUV (US Small Cap Value ETF):** Management fee 0.35%. Heavily tilted towards the smallest, cheapest, and most profitable U.S. market stocks, excluding large stocks. It is expected to have high expected returns but also significant tracking error. Its U.S.-listed equivalent, AVUV, has outperformed the U.S. market since September 2019, though with periods of underperformance. * **CADE (International Equity ETF):** Management fee 0.29%. Invests in total market international developed market stocks with a moderate tilt towards smaller, cheaper, and more profitable companies, excluding Canada. Its U.S.-listed counterpart, AVDE, has outperformed international developed markets since September 2019. * **CASV (Global Small Cap Value ETF):** Management fee 0.39%. Offers exposure to a globally diversified portfolio of small-cap value stocks, emphasizing the smallest, lowest-priced, and most profitable companies. It's expected to perform very differently from the global stock market. Its U.S.-listed equivalent, AVDV (excluding U.S. stocks), has significantly outperformed international developed markets. * **CAEM (Emerging Markets Fund):** Management fee 0.39%. Follows the same principles of tilting toward higher expected return stocks across emerging markets. Its U.S.-listed version, AVEM, has outperformed cap-weighted emerging markets since inception. While these performance histories are short, Dimensional Funds, which employs a similar approach, has decades of history demonstrating long-term outperformance relative to comparable Vanguard funds. The most exciting product, according to the presenter, is **C A (Avantis CIBC All Equity Asset Allocation ETF)**. With a single ticker, it provides a globally diversified stock portfolio with a Canadian home country bias and built-in tilts towards smaller, cheaper, and more profitable stocks. This offers a one-stop solution for a low-cost, broadly diversified portfolio that leverages financial economics research and mitigates some downsides of index funds. The theoretical underpinning for these tilts is explained through the dividend discount model and the Fama-French five-factor asset pricing model (2015). The valuation equation derived from these models suggests three statements about expected stock returns: 1. **Value Premium:** A lower market value to book value ratio implies a higher expected stock return (cheaper stocks have higher expected returns). 2. **Profitability Premium:** Higher expected earnings imply a higher expected stock return (more profitable companies have higher expected returns). 3. **Investment Premium:** Higher expected asset growth implies a lower expected stock return (companies with higher investment tend to have lower expected returns). These concepts lead Avantis to systematically tilt towards smaller, cheaper, and more profitable companies. The premiums have been observed in stock returns globally for as long as data exists, though they can experience periods of underperformance. A crucial insight is that these premiums should not be considered in isolation. For example, focusing only on profitability without controlling for price might lead to overpaying for growth, while focusing only on value might lead to investing in companies with weak profitability ("cheap for a reason"). The highest expected returns come from stocks with both low relative prices and robust profitability, which is precisely what Avantis targets. This approach is not just about earning higher expected returns; it's also about targeting multiple return premiums that may perform well at different times, potentially leading to a more reliably positive long-term outcome. For instance, during the U.S. "lost decade" (1999-2010), when the overall market was flat, small-cap and value stocks delivered positive returns. In conclusion, while low-cost market cap-weighted index funds are sensible for most investors, they only offer exposure to the market premium. The Avantis ETFs provide access to other well-established return premiums systematically and at a low cost. The launch of CIBC's Avantis ETFs makes this investment approach more accessible to Canadian investors. The presenter also reiterates the importance of Avantis's approach to IPOs, noting that unlike cap-weighted index funds that may be forced to buy shares of large private companies (like SpaceX or OpenAI) at high prices upon their IPO, Avantis funds will only include them if they meet specific financial criteria and trade at an attractive price.