Lest there was any remaining doubt about investor preferences for exchange-traded funds over mutual funds, the mutual fund industry is setting new records for ETF conversions in 2024.
According to Morningstar, there have been 55 ETF conversions this year through Dec. 17, which compares to 35 last year and 20 in 2022.
The majority of the conversions this year have been in the fixed income space, including 30 from Stone Ridge Asset Management’s lifecycle funds, but the movement is undeniable, nonetheless.
“The trend of mutual funds converting to ETFs shows no signs of abating,” said etf.com Senior ETF Analyst Sumit Roy.
“The last bastion for mutual funds, active funds, are now one of the fastest growing categories within ETFs,” he added. “Fund managers no longer have an excuse not to convert, with ETFs offering a superior investor experience across almost every dimension.”
At about $35 trillion, the mutual fund industry is still more than three times the size of the ETF industry, but the direction of flows into ETFs and out of mutual funds has become a multi-year drumbeat that is only getting louder.
Ryan Jackson, senior manager research analyst at Morningstar, cites Dimensional Fund Advisors with opening the ETF conversion flood gates in 2021.
“DFA really got the ball rolling and gave the rest of the mutual fund industry a blueprint for what can be done with ETF conversions,” Jackson said.
DFA, which has nearly $800 billion in total assets under management, has grown its ETF footprint to 38 funds that combine for more than $155 billion.
While ETF conversions are easy to measure, Jackson said a trend that is harder to track and quantify is ETF clones being launched by mutual fund companies.
“We’re seeing a lot of shops replicating popular mutual fund strategies as new ETFs,” he said. “That’s not a conversion, but it’s getting at the same idea.”
Jackson described ETF conversions as one of the remaining lifelines for legacy mutual fund companies that are clinging to the retirement plans as their remaining stronghold.
One other area of hope for mutual fund companies is ETF share classes, which at least three dozen mutual fund companies have applied for with the Securities and Exchange Commission.
An ETF share class, which was developed by the Vanguard Group but has yet to be approved for any other fund company, essentially bolts an ETF onto an existing mutual fund.
While the SEC is not required to rule on ETF share classes and is not on any kind of timeline to rule, Jackson believes approval is imminent within the next year or so.
“I would think ETF share classes would bring ETF conversions to a screeching halt,” he said.
Until that time comes, the mutual fund industry will continue to weigh the pros and cons of converting mutual funds into ETFs, and there is much to consider, according to Jackson.
“When you convert the main thing you give up is the ability to close your doors to new investors, and that’s what makes a lot of strategies potentially bad fits for the ETF structure,” he said.
Unlike a mutual fund that can close to new investors, an ETF trades all the time just like a stock, and certain strategies, such as small cap equities or niche international, could find it difficult to manage without being able to control asset flows.
“We have not seen that happen yet, but we’re waiting for it,” Jackson said. “We think it will happen in the next couple of years when someone jumps the gun and gets more than they bargained for,” by converting a niche mutual fund strategy into an ETF.