Fido (hearts) ETFs
ETFs are kind of a big deal these days. And not just because of the massive sucking sound generated by hundreds of billions of dollars flowing into them, even in a year like 2022.
The global ETF industry took in another $116bn of net inflows in October, taking the total so far this year to $708bn, according to ETFGI. That’s pretty stupendous, given that this is one of the worst years for financial markets on record.
But there are myriad signs of the ETF’s ascendancy. From our colleague Sonya Swink over at FT Ignites last week:
Fidelity plans to convert a set of six “disruptive technologies” mutual funds to exchange traded funds next June, the firm has disclosed. These will be the first mutual funds that Fidelity will turn into ETFs, a company spokesperson said.
The $96mn Fidelity Disruptors, $91mn Fidelity Disruptive Automotion, $80mn Fidelity Disruptive Technology, $48mn Fidelity Disruptive Finance, $47mn Fidelity Disruptive Medicine and $34mn Fidelity Disruptive Communications mutual funds will become ETFs with the same name by June 16, the filing says.
It’s easy to dismiss this as an entirely natural but unremarkable conversion of six gimmicky funds into six gimmicky ETFs. The $430mn of assets is like a gnat compared to the Fidelity elephant ($3.6tn at the end of September). That Fidelity is also halving the funds’ fees makes it look mostly like a desperate attempt to keep this suite of “thematic” ETFs alive.
But it another sign of the rise of the ETF structure, even for active investment strategies and mutual fund stalwarts like Fido.
Mutual funds are never going to die — there are still squillions of dollars in them, and for the most part they work fine. In some respects, they work better. ETFs cannot be closed to new investors if the strategy faces capacity constraints, for example (eg, ARKK). The mutual fund is the incumbent in an industry where inertia is a powerful force. But it is starting to look like the coming age of investment fund structure might be dominated by ETFs.
Despite its passive roots, the ETF is a pretty flexible fund wrapper, and there are more and more signs that active asset managers are beginning to embrace it over traditional mutual fund structures, especially in the US. There, ETF fund launches are outpacing the birth of new mutual fund, and there has been an intriguing flurry of conversions à la Fidelity’s.
This is a pretty recent trend. The first active ETF was launched all the way back in 2008 (RIP the Bear Stearns Current Yield Fund) but the very first mutual fund-to-ETF conversion was done as recently as March 2021 by Guinness Atkinson Asset Management.
The first big move was Dimensional Fund Advisors converting four mutual funds with almost $30bn of assets in June 2021, instantly making it one of the biggest ETF issuers (in an admittedly wildly top-heavy industry). Soon afterwards JPMorgan Asset Management converted a $10bn suite of funds, and while Capital Group hasn’t converted any funds into ETFs it has made a splashy entry into ETFs.
This is pretty notable. Capital — a company that viscerally dislikes anything associated with passive investing — has about $3bn in the ETFs it launched earlier this year. (UPDATE: Todd Rosenbluth at VettaFi points out that Capital’s overall ETF assets now stand at $5.2bn. The previous figure was from an earlier press release).
FTAV actually had a chat with Capital’s ETF head Holly Framsted back in April, and she made some interesting points about the ETF shift. From our notebook, with our emphasis:
I can see a world where they [mutual funds and ETFs] are close to equal. Mutual funds are custom-built for retirement, but we are realising that financial advisers are thinking more broadly about portfolios, and that is where the ETF comes in… We expect it will be a meaningful contributor [to Capital Group’s business].
Of course, most of the conversions and big splashy new ETF initiatives have happened in the US, where ETFs enjoy a tax advantage over mutual funds (investor’s don’t have to pay capital gains tax until they sell the ETF).
But as Framsted said, it’s also driven by how financial advisers now construct portfolios for their clients, assembling them with Lego-like blocks of ETFs. And this is why the ETF growth/conversion trend could have much further to run. It’s the distribution, stupid.
Yes, it’s going to be a slow and more muted shift in more bank-dominated countries (bank-employed advisers, oddly enough, prefer to recommend their own employer’s expensive in-house active mutual funds). But if you think that more and more is going to migrate online and on to commission-free phone apps — including in Europe and Asia — then the tradability of ETFs makes them much easier to distribute.
And that’s why we suspect this could only be the beginning of the big mutual fund-to-ETF conversion wave.