In the dispute between mutual funds and exchange-traded funds, investors have recently been voting with their portfolios on ETFs. At least three fund issuers now plan to convert some of their mutual funds into ETFs
ETFs can be traded all day long as stocks, as their prices go up and down. Often, they have lower costs and result in lower tax expenses than mutual funds.
But mutual funds, whose price is charged only once a day, may be more stable in some ways. During a two-week period in March, when markets became volatile, bond ETFs were traded at deep discounts on their net asset value, or NAV, which is the value per share of the fund’s holdings. This means that if you had wanted to sell your fund in the midst of the turmoil, you would have faced even greater losses than justified by the market’s decline.
Bond ETFs are usually traded at prices close to NAV, but during the so-called panic pandemic, some of the leading bond ETFs were traded at discounts of 7% or more before recovering in April. Partly due to the daily price of mutual funds, its investors did not face the same problems.
Dimensional Fund Advisors of Austin, Texas, filed for an order to convert four tax-managed mutual funds and two central mutual funds into ETFs in November, a measure that the company’s projects will reduce management fees by up to 0.15%. Milwaukee-based Guinness Atkinson Asset Management plans to convert several funds, as does Nottingham Company, a Rocky Mount, NC, fund manager.
Dimensional Fund Advisors does not expect to convert any additional mutual funds, said Marlena Lee, global head of investment solutions for the company. “As we want to offer our customers options on how to invest with us, we aim to have a full line of mutual funds and ETFs,” said Dr. Lee.
Investors can also turn to other mutual fund companies, such as Vanguard, which offer ETF versions of some of their mutual funds.
While mutual funds still outnumber ETFs, with $ 22.5 trillion in assets compared to $ 4.7 trillion in ETFs, the recent trend has favored exchange-traded funds. ETFs posted total inflows of more than $ 509 billion in 2020, according to Elya Schwartzman of ES Investment Consulting in Marin County, California. Schwartzman projected that mutual funds raised just $ 209 billion during the year. This includes $ 679 billion that flowed into money market mutual funds in search of a safe haven.
Without money market entries, long-term mutual funds lost $ 470 billion in outflows in the year. Only 32% of mutual fund issuers recorded net cash inflows in 2019, compared with 74% of ETFs, according to the Investment Company Institute, a commercial group.
ETF managers point to a number of specific benefits of exchange-traded funds compared to traditional mutual funds. They include greater transparency in shareholdings and lower operating costs. And because of the way mutual funds are structured, investors may find themselves owing capital gains taxes at the end of the year, even if they haven’t redeemed shares and even though the stock price ended the year at a loss, a surprise unlikely for ETF shareholders, who pay capital gains only when they sell the fund at a profit.
Another advantage cited by Jim Atkinson, chief executive of Guinness Atkinson Asset Management, is the ability to trade ETFs during the day.
“With mutual funds, you don’t know the real price,” said Atkinson. “With an ETF, you can place a market order and find out what the price is. Many consultants don’t like to put their clients in a position where they don’t know the price by the end of the day. “
Guinness Atkinson has been working on converting these funds since mid-2018. This included negotiating with regulators and contacting shareholders.
The conversion process is complex. Fund managers will generally start a facade ETF and then merge the existing mutual fund into the new ETF. This will prevent shareholders of the converted mutual funds from paying taxes due to the change.
Unlike many ETFs that mimic established indices – such as the S&P 500 – these converted funds will continue to be actively managed along the lines of the mutual funds they replace.
“I think it is great for investors and in the long run it will be a good thing for companies that are making this change,” said Andy Kapyrin, partner and co-director of investments at RegentAtlantic, a wealth manager in Morristown, NJ . “Mutual funds were revolutionary, but ETFs are just a newer, better technology.”
But Kenny Polcari, a managing partner at Kace Capital Advisors in Boca Raton, Florida, doesn’t see many advantages for ETFs. For example, Mr. Polcari prefers the relative opacity of mutual funds and their quarterly reports of their holdings because this is less frequent and disclosure prevents investors from participating in spot trades based on what the fund buys or sells.
“Managers claim that these funds are actively managed and that they could be managed more actively than current ETFs, but I prefer a mutual fund with a more long-term approach,” said Polcari. “I don’t think it is the next investment vehicle that everyone will migrate to. It looks sexy, but I wouldn’t go into an actively managed ETF. “
Fund managers say they have been responding to requests from their clients for years to add ETFs that they can use to create customized portfolios for their investors. The Securities and Exchange Commission approved new rules for ETFs that went into effect in December, eliminating a long and expensive approval process for new funds and allowing for new potential tax benefits for companies that issue ETFs