Exchange-traded funds (ETFs) have quickly gathered assets to become one of investors’ preferred vehicles to build portfolios. However, those assets haven’t always come from new launches. In recent years, the trend of converting mutual funds to ETFs has become a major driver for asset gathering and fund launches. Billions of dollars’ worth of mutual funds have now converted to the ETF structure.
And now, those conversions are coming to other fund structures as well.
Closed-end funds (CEFs) and separately managed accounts (SMAs) have now been tapped from issuers to begin converting into ETFs. That’s a big deal for the world of active ETFs. Not only does it prove the validity of the ETF structure, but it could lead to plenty of asset gathering and even some gains for investors.
ETF Conversions Surge
For many traditional asset managers, the writing may be on the proverbial wall. As investors have continued to embrace the ETF structure for both passive and active investments, other fund structures have started to see their assets dwindle, which has led to the decline of mutual funds. If it weren’t for investment gains, assets in mutual funds would be much lower than they are today. To this end, many asset managers have started to add ETFs to their menus.
But starting an ETF brand from scratch is particularly hard and costly.
To that end, many have started to take their existing mutual funds and convert them into ETFs. The trend was kicked off by alternative asset manager Guinness Atkinson. Following from this, major issuers such as Dimensional Fund Advisors (DFA), J.P. Morgan, Fidelity, and Capital Group all converted several large funds into ETFs. Some of these converted funds already held billions in assets. With that, firms now have viable ETF brands under their wings.
According to Morningstar, over 70 mutual funds have converted to ETFs since 2021, totaling over $100 billion. The number continues to surge with heavy hitters like BlackRock now planning their first mutual fund-to-ETF conversions.
Other Structures Enter the Conversation to Convert
But mutual funds aren’t the only way investors can build a portfolio. There are plenty of other vehicles that offer exposure to various asset classes. And it looks like those various structures are on deck for conversions to ETFs too. This includes both CEFs and SMAs.
CEFs are one of the oldest fund structures around and are launched via an IPO with a fixed number of shares. The shares of the CEF are subsequently traded on the major exchanges at discounts or premiums to their underlying net asset values. In separately managed accounts (SMAs), investors physically own the individual stocks, ETFs, and bonds in the portfolio under the guidance of the asset manager. An asset manager may have hundreds of investors in a single SMA strategy.
While these structures have their benefits, they also have some cons, particularly when compared to ETFs.
With that, both First Trust and Eagle Capital Management have undergone moves to convert these structures into new ETFs.
In late 2023, First Trust converted the First Trust Dynamic Europe Equity Income Fund (a CEF) into a new ETF, the First Trust Active Global Quality Income ETF (AGQI). Its latest move involves converting four energy and MLP-focused CEFs into a new ETF. The First Trust Energy Income and Growth Fund, First Trust MLP and Energy Income Fund, First Trust New Opportunities MLP & Energy Fund, and First Trust Energy Infrastructure Fund were swallowed up by the newly launched FT Energy Income Partners Enhanced Income ETF (EIPI). EIPI will follow a similar active mandate as many of the CEFs, providing exposure to energy stocks and MLPS while adding a covered call strategy. All in all, about $1 billion in assets were converted into EIPI.
For Eagle, it was about its SMA strategy and using scale to develop a new ETF. The asset manager had many clients in this particular strategy, so it made sense to convert all of these accounts into a single ETF. The new Eagle Capital Select Equity ETF will follow a similar strategy as the SMA, building a portfolio of quality stocks with high conviction. All in all, the ETF conversion was over $1.8 billion.
Big Wins for Investors…
For investors, the conversions could be seen as a big win on several fronts. The ETF structure has proven itself for both passive and active strategies. This includes both tax efficiency and costs.
Both CEFs and SMAs can be a bit costly on the expense ratio front. Thanks to their ability to use leverage, many CEFs typically charge over 1% in fees. At the same time, SMAs feature management fees as well as embedded costs if they also hold CEFs, ETFs, and other funds within the account. At the same time, there can be trading costs associated with them.
Additionally, taxes could be a concern. CEFs often feature very ‘interesting’ taxes when it comes to their distributions. Return of capital usually dots 1099 forms come tax time. SMAs are similar in that investors may not have a choice when they experience capital gains or there could be big tax consequences when they decide to sell out of the strategy.
CEF investors may also have another big win if a fund converts, namely instant gains. Many CEFs trade at discounts to their actual values. When a fund converts, that discount is instantly realized.
…And Asset Managers
For asset managers, there are wins as well. By converting some of these legacy CEFs and funds, they instantly gain a viable ETF platform or are able to expand on an already existing one. In the case of First Trust, the firm already has a strong line-up of ETFs, both active and passive. This gave it an opportunity to expand that platform while reducing asset bleeding. For Eagle, it instantly gave it one of the largest active ETFs on the market.
According to the Investment Company Institute’s (ICI) last Fact Book, there are more than 440 different CEFs that hold over $252 billion in assets. This chart shows the potential in conversions along with the more than 8,700 mutual funds.
Source: ICI
That’s a lot of funds that have the ability to become ETFs going forward. For asset managers, conversions will allow them to keep more fees (albeit lower) in-house. Volume is the name of the game with ETF management. So getting big and staying big is key. With CEF and SMA conversions now on the table, getting big may have gotten easier.
In the end, investor preferences have continued to change. And that has more of them choosing ETFs. Asset managers with large closed-end funds and separately managed account platforms have the ability to give investors what they want.
Popular Active ETFs
These ETFs are the largest active ETFs on the market, with several launching as conversions. They are sorted by YTD total return, which ranges from -1.8% to 12.6%. They have expense ratios between 0.17% to 0.36% and have assets under management between $7.5B to $33B. They are yielding between 0.8% and 9.7%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| JEPQ | JPMorgan Nasdaq Equity Premium Income ETF | $11.8B | 12.6% | 9.7% | 0.35% | ETF | Yes |
| DFAC | Dimensional U.S. Core Equity 2 ETF | $26.1B | 8.4% | 0.8% | 0.17% | ETF | Yes |
| DFUV | Dimensional US Marketwide Value ETF | $9.9B | 7% | 1.5% | 0.21% | ETF | Yes |
| JEPI | JPMorgan Equity Premium Income ETF | $32.8B | 5.3% | 6.9% | 0.35% | ETF | Yes |
| MINT | PIMCO Enhanced Short Maturity Active ETF | $11B | 2.5% | 5.3% | 0.35% | ETF | Yes |
| JPST | JPMorgan Ultra Short Income ETF | $22.8B | 2.2% | 5.4% | 0.18% | ETF | Yes |
| AVUV | Avantis U.S. Small-Cap Value ETF | $10.9B | 1.30% | 1.4% | 0.25% | ETF | Yes |
| DFAT | Dimensional U.S. Targeted Value ETF | $10.1B | 0.4% | 0.8% | 0.28% | ETF | Yes |
| FBND | Fidelity Total Bond ETF | $7.5B | -1.8% | 4.8% | 0.36% | ETF | Yes |
The Bottom Line
ETFs are quickly becoming the top choice for investors to build portfolios. And asset managers are quickly finding ways to fill that demand. This includes now converting legacy closed-end funds and even separately managed accounts into ETFs. In the end, everyone wins in the process.