Given their benefits, it’s easy to see why active exchange-traded funds (ETFs) have caught on like wildfire with advisors and investors of all sizes. Growth in ETFs has been swift, and there are now trillions of dollars globally in the fund type. This poses an interesting problem, however, for traditional asset managers who focus on mutual funds.
Mutual funds have been dying a slow death for years now, and the surge in active ETFs has exacerbated that fact. Mutual fund providers are now staring down the barrel of an exchange-traded gun.
But Dimensional Fund Advisors (DFA) may have the solution. With its massive multi-billion dollar conversion of its traditional mutual funds into active ETFs, DFA shows how asset managers can compete in the new ETF-heavy environment and not fade into the dust.
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A Big Powerhouse
You may not have heard of Dimensional Fund Advisors before, but they are very important asset managers and they started several important investing trends. DFA was one of the first investor managers to embrace so-called factor investing. Founder David Booth was a direct student of famed economists Eugene Fama and Kenneth French at the University of Chicago. Fama and French’s work focused on various factors when looking at historical returns. By isolating factors – like size, value, momentum, quality, etc. – Fama and French created a new paradigm for investing, risk-adjusted returns, and modern portfolio theory.
Booth and his co-founders ran with the idea and set up DFA as a way to exploit factor investing. With that, DFA was one of the early adopters of the style, and they’ve been able to produce market-beating returns for their investors.
The reason why DFA may not be well known among the retail investing set is that DFA was originally set up to be an advisor-only mutual fund group, with only specific financial advisors having access. Whereas you could open up a brokerage account and buy a T. Rowe Price mutual fund, or call up Vanguard directly to purchase, DFA required investors to hunt down one of its specific advisors and open an account.
Despite that fact, the fund company saw its assets under management surge and it quietly became one of the largest mutual fund providers, with nearly $680 billion under management.
DFA Makes A Big Shift
One of the reasons why DFA has been successful is that they were forward thinking in portfolio construction back when no one was considering factor investing at all. The same could be true today with its latest moves – factor investing has been commoditized with ETFs. With a simple click of a mouse, you can now add size, momentum, etc., to a portfolio. As such, ETFs like the iShares MSCI USA Quality Factor ETF (QUAL) have gathered billions in assets.
With this, there’s no need to add a special advisor to access the opportunity. In fact, you don’t even need an advisor at all. Growth at DFA has slowed in recent years. Sensing the shift, DFA once again has focused on its forward thinking.
The manager recently converted six of its largest and most popular mutual funds into active ETFs. This instantly gave the firm more than $37 billion in active ETFs on the market. Secondly, the firm launched several more active ETFs covering factor fixed income investing. This brought the firm’s total haul to more than $45 billion in active ETFs under management. It also made the firm the largest issuer of active ETFs on the planet. All in all, DFA plans to convert more funds and launch 10 more active ETFs. According to the SEC filing, this includes two U.S. ETFs, four international ETFs, three emerging markets ETFs, and one U.S. real estate ETF.
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A Game-Changing Move
Simply put, the move by DFA is game changing for the industry. The firm has long been a leader in showing the power of active management and has provided top returns for its investors. By shifting its portfolio into ETFs, DFA can make that history even better by offering a tax-efficient mechanism (thanks to the creation and redemption process of ETFs) for its active management as well as lowering fees. Both of these provide better returns for investors. By offering ETFs of its top funds, DFA should be able to overcome the issues plaguing the mutual fund industry, see growth return, and boost assets under management.
DFA’s moves to convert put the rest of the mutual fund industry on watch/high alert. Asset management is quickly becoming a game of inches, and with outflows from mutual funds into passive/active ETFs growing, fund sponsors need to act now if they want to succeed in the new environment. DFA’s conversion highlights that success can be found by undertaking the strategy. Already, J.P. Morgan and Capital Group have announced plans to make mutual fund to ETF conversions as well. Smart fund sponsors should follow suit or be left in annals of Wall Street history.
The bottom line is that more traditional mutual fund sponsors will take DFA’s lead and convert their funds. ETFs offer the best way for active managers to gather assets and showcase their talents.
Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.