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Key takeaways
- 121 actively managed mutual funds have converted to ETFs since a regulatory rule change made it feasible. The verdict so far:
- Conversions are good for issuers: the ETF wrapper can staunch outflows and revive funds, attracting $250mn inflows per year.
- Conversions are good for investors: ETF efficiency can add 120bps in gains per year vs. an identical mutual fund.
The end of active investing? Not so fast
Since the creation of ETFs in 1993, there have been $5tn of outflows from active equity mutual funds, and some investment managers have struggled to respond. But in 2019, a regulatory rule change allowed mutual funds to convert into ETFs and retain their track records and assets. In this report, we assess the impact five years on.
The ETF advantage: conversions attract new money
The evidence so far is clear: ETF conversions can stem the tide of outflows and attract new capital. So far, 121 active mutual funds have become active ETFs. Two years before converting, the average fund saw $150mn in outflows. After converting, the average fund gained $500mn of inflows (Exhibit 1). This "ETF advantage" has been evident both for funds that outperform their benchmark and for those that don't (Exhibit 5).
The win-win case for ETF conversions
Conversions also seem attractive for investors: the ETF structure offers big tax savings (1.20%/year in lower costs; $250bn saved so far) and greater transparency and liquidity. Conversions also work for fund issuers: the average convert earns 45bps more in fees than a typical ETF, and 30bps more than other active ETFs. Even after expense ratio reductions, typical fund economics are above breakeven within 12 months of converting.
Investors pay for "Interesting"
The most successful active conversions have offered differentiated access to markets or strategies with fewer ETF competitors, including "quantamental" equity, high-yield fixed income, thematic funds, and options strategies.
Conversions of another $3bn in funds are already planned for 2025. There are still $28 trillion managed by >7000 mutual funds, and we identify 400 funds for whom ETF conversions may be attractive. As the market becomes more competitive, managers with assets under pressure may decide to convert while they still can.
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The third era of ETF growth
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An ETF conversion can be a winning issue
Conversions offer many benefits to asset managers. We find that reorganizing as an ETF has increased flows by $500mn after 2 years, on average, and that successful mutual fund to ETF conversions can improve fund revenues in as little as 12 months. Conversions so far have included many differentiated and thematic strategies. Investors have been more likely to embrace conversions in segments with less competition.
Out(flows) with the old, in(flows) with the new
In our study, reorganizing as an ETF increased average monthly flows by three percentage points (Exhibit 4 & Exhibit 5), seemingly without regard for manager alpha.
In recent years, outflows from mutual funds have affected even managers with s trong returns. Among converted funds, outperforming managers averaged a 1% monthly outflow in the two years prior.
In contrast, we find that converting to an ETF has helped even some laggard managers. The average underperforming ETF still saw +1.3% inflows per month post-conversion.
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Active strategies go from attritional to attractive
Even amid intense competition in the ETF market, we find that the average ETF gains enough in flows to offset a lower fee base (Exhibit 9). On average, funds lower their expense ratios 30bps during conversion. The average converted ETF expense ratio, however, is still 20bps higher than the active ETF industry average. Offering differentiated market access or "interesting" strategies seems to allow issuers to earn above-average fees, reducing the revenue impact from the change in legal structure (Exhibit 10).
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What makes a successful ETF conversion
Most conversions offer access to differentiated markets or investment strategies.
Other strategies comprise the other two thirds of conversions in areas such as:
- Active fixed income: we find 17 funds investing in fixed income sectors, such as IPPP (preferreds), HYFI (high yield) and EVTR (aggregate bond), and MBS (MBS).
- Options strategy funds have grown dramatically since 2022. Funds like NBOS, BUYW, and SHDG recently converted to tap into this enthusiasm.
- Target date ETFs have been the largest category of conversions in 2024. StoneRidge changed 32 funds in October.
- Thematic funds include FDFF, AQGX, and BUDX.
- Event driven funds like EVNT and SPAQ offer niche strategies that may be better suited for tactical trading opportunities via the ETF wrapper.
In Exhibit 13, we show the distribution of ETF conversions across sectors and asset classes, with details on the post-conversion change in fund flows and assets. Of 15 categories, only three have sustained outflows on average. Eight categories have seen double-digit inflows as a % of AUM since conversion.
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Conversions are good for investors, too
ETFs also offer several key advantages for investors. First, no minimum investment means that ETFs are flexible, helping investors "add back" the diversification now missing from many stock and bond core portfolios (see our primer for more details). Second, ETFs offer greater liquidity, more transparency, and access to more markets.
Finally, with lower fees and a tax-optimized structure, ETFs have saved investors more than $250bn since 2001. Annual all-in costs for ETFs are 1.2% lower than mutual funds (Exhibit 17).
For the same investment, taxable events mean mutual funds cost investors 1.3% per year vs. just 0.4% for ETFs. An investor who bought $100,000 of an S&P 500 ETF in October 2013 and held through today would have accumulated $359,000, compared to just $316,000 if the investment was in an S&P 500 mutual fund (Exhibit 16).
These savings scale up for investors in all tax brackets. We estimate that ETFs have helped save investors $250bn in taxes since 1993, even when accounting for the 57% of mutual funds currently held in tax-sheltered accounts by US households.
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Conversions to come
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Appendix: ETF-Mutual Fund relationships
We've identified three types of ETF-mutual fund relationships that exist today.
- Conversions: An ETF replaces an existing mutual fund via acquisition or liquidation of the mutual fund, the operational burden shifts to support the ETF.
Many issuers are opting to replace a mutual fund wrapper for an ETF wrapper while maintaining the same strategy, manager, and asset base. The new ETF will assume the live track record of the old mutual fund. On average, fees for the converted mutual fund will fall to be competitive in the mutual fund space. This strategy can be an opportunity to market a strategy in a tax efficient way.
- Clones: An ETF and a mutual fund have similar or identical strategies and are offered by the same provider, but there is no operational overlap.
Typically, two funds are offered at different price points and marketed separately. Even if both funds reference the same strategy, live history is anchored to the inception date of each fund. We approximate that there are 200 "clones" today.
- Co-listings: An ETF fits within the mutual fund share class structure and the funds are operationally linked.
The create/redeem features of the ETF provide a tax benefit to the mutual fund. This is a benefit to the investor, decreasing the tax drag of co-listed mutual funds.
A co-listed ETF will assume the live track record of the mutual fund. The ETF share class can have a separate fee from other mutual fund share classes, which may offer advantages from a revenue and marketing standpoint.
Co-listings had been protected by a patent granted to Vanguard. The patent expired in May 2023 and the SEC is now reviewing filings from other companies that would like to offer co-listings. Co-listings are not appropriate for all managers. Unlike a mutual fund, ETFs cannot reject orders to prevent capacity issues. If a strategy could be exposed to capacity issues, an ETF share class may not be appropriate.
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Exhibit 4 and 5
Manager performance = Annualized 3Y returns of active strategy minus annualized 3Y returns for a passive ETF alternative. Average monthly flows for mutual funds calculated beginning 2 years before conversion. Excludes funds without 3 years of total active history, with less than 3 months since conversion, and without applicable benchmark.
Exhibit 10
Assumptions Using simple averages from existing converted ETF universe. $1000mn fund, $10mn outflows per month as mutual fund, $20mn inflows per month as ETF. 0.90% expense ratio as mutual fund. 0.60% expense ratio as ETF.
This example does not consider operational expense, front end, or back-end fees. Mutual funds are generally migrating to a no-load structure.
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 Important Disclosures
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EXCHANGE-TRADED FUNDS (ETF) INVESTMENT OPINION KEY: Opinions reflect both an Outlook Rating and a Category Rating. OUTLOOK RATINGS reflect the analyst's assessment of the ETF's attractiveness relative to other ETFs within its category (including sector, region, asset class, thematic, and others). There are three outlook ratings: 1 - the ETF is more attractive than covered peers in the same category over the next 12 months; 2 - the ETF is similarly attractive to covered peers in the same category over the next 12 months; and 3 - the ETF is less attractive than covered peers in the same category over the next 12 months. CATEGORY RATINGS, indicators of the analyst's view of the ETF's category and which incorporate published views of BofA Global Research department analysts, are: FV - Favorable view, NV - Neutral view and UF - Unfavorable view.
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