One of the fund industry themes expected to loom large at the start of 2023 was the ongoing conversion of actively managed mutual funds to the exchange traded funds structure – a logical step when considering the latter has been pilfering assets from the former for years.
In some instances, there are doubts about the asset-gathering acumen of former mutual funds turned new ETFs, but the fact remains this is a shift many legacy mutual fund issuers are embracing the pace of such conversions will likely ramp up as 2023 unfolds. There are already signs of that occurring.
For example, Mirae Asset Global Investments – the parent company of ETF sponsor Global X – recently converted two mutual funds to the ETF structure. Those funds are the Emerging Markets Great Consumer ETF (EMC) and the Emerging Markets ETF (EMM).
“Both strategies carry 12+ year track records of long-term outperformance relative to their benchmark, the MSCI Emerging Markets Index.The funds have maintained their teams, investment processes, and investment philosophies, but are now offered as ETFs. Both funds seek to achieve long-term capital growth by investing in equity securities in emerging markets (EMs),” according to Global X.
Why Mutual Fund to ETF Conversions Matter
Advisors are right to be skeptical of mutual fund issuers converting to ETFs, but there’s merit to this strategy. Consider this: Dimensional Fund Advisors (DFA) – a name familiar to scores of advisors – is already the eighth-largest ETF issuer in the US on the back of converted mutual funds.
Several other big names from the mutual fund space are crawling up the ETF assets ladder by way of shifting existing products to ETFs. Clients like this strategy, too. The reasons for the adulation include the prospect of lower fund fees and enhanced liquidity. Plus, ETFs are more tax-efficient than active mutual funds.
“ETFs are generally more tax efficient than their mutual fund counterparts, as they typically generate fewer capital gains for investors. This is largely due to ETFs’ ability to use an in-kind creation/redemption process with Authorized Participants to limit the amount of taxable events,” adds Global X.
Of course, a bad strategy is a bad strategy regardless of the wrapper. That is to say a fund that’s a dud as an active mutual fund isn’t likely to suddenly change its spots as an ETF. Translation: Some converted mutual funds will be success stories as ETFs. Others won’t be so fortunate.
The Vanguard Effect
Advisors that are fund nerds and those that actively stay abreast of industry goings on likely know that on May 16, a patent expired that allowed select share classes of some Vanguard mutual funds to function as ETFs.
The methodology, pioneered by Vanguard in 2001, helped the firm to become the second-largest ETF issuer in the U.S. and it’s making inroads on the top spot. It’s viewed as a controversial though ethical and legal way of operating in the fund universe.
Should the Securities and Exchange Commission (SEC) allow for that methodology to be replicated, the flood gates could open to more mutual funds to embrace the ETF label. Point is the trend isn’t going away, it’s not a fad and it’s worth advisors’ time to monitor.
Related: Why Thematic ETFs Still Matter