Conversions create ETF giants

Marlena Lee, Dimensional

There has been quite the conversion outbreak in the ETF world in the latter half of this year, with a number of US-based asset managers converting their existing funds into ETFs.

The new ETF rule, 6c-11, lies behind much of it, allowing as it does, a wider range of fund strategies within the ETF wrapper. But pressure on fees is another driver. Most notable converter is Texas-based Dimensional Fund Advisors which is on the path to convert six of its mutual funds, with total assets of USD30 billion, into actively managed ETFs during early 2021, having launched its first standalone ETFs earlier this year. 

Dimensional, already a substantial investment house with USD527 billion in assets, is now on the path to be one of the biggest ETF providers in the world. 

Marlena Lee, Head of investment solutions at Dimensional says: “After the conversion we expect to reduce the management fees by 27 per cent,” and with what one imagines is impressive understatement, she adds: “Clients have been happy.” 

The mutual funds in questions were ‘tax-managed’ and so the additional tax breaks offered through ETFs added to the appeal of the package. 

“The six mutual funds have had very similar tax efficiency to what is out there in the ETF market but the conversion provides a better solution for managing the timing of capital gains,” Lee explains.

“When we find a way to improve a solution and to better meet the goals of delivering higher after tax returns we will work to get that benefit for our clients,” she says.

In September, earlier in the year, Fayetteville, Arkansas-based Cabana Asset Management enjoyed a similar moment of conversion, becoming an instantly successful ETF issuer, with some USD1.1 billion of assets under management through the conversion of its hedge fund-like actively managed funds into ETFs.

In this case, the conversion was from managed account to ETF. Chadd Mason, Cabana’s CEO, explained at the time that the ETF rule allowed the basket creation and redemption process to be applied to taxable ETFs.

“It’s a home run for us to offer our portfolios in the ETF structure,” Mason said at the time. “It’s a more liquid, transparent and more efficient structure that removes multiple layers of cost…And we believe it opens up a whole other line of business for them as its tax efficient and you can grow assets indefinitely.”

Meanwhile, over in Wichita, Kansas, wealth manager 6 Meridian was also doing a little converting.

Responding to a request from investors for a less cumbersome investment product than the separately managed account, the firm launched four ETFs.  “The process was entirely driven by our existing clients, wanting to provide to them with a simpler way to invest with the added tax advantage of an ETF,” said Andrew Mies, CIO of 6 Meridian in our interview with him in September.

The much-vaunted tax advantage of the ETF comes because, in the US, an ETF working through the creation and redemption process to maintain the portfolio, through the heartbeat trading process raises no CGT on the underlying transactions, giving the structure an expected tax advantage over other pooled investments.

Rumours have been circulating that a new Democratic government might be re-examining the ETF’s tax advantage but nothing has happened yet and observers comment that it would take a very long time for any regulatory change to be made, given how long it took for the ETF rule to be in place.

But the underlying investment must remain key, says Dimensional’s Lee. “When we set about setting fees, we want to make sure that people are evaluating our solutions based on our investment proposition and that fees shouldn’t be an impediment,” she says. 

Author Profile
Beverly Chandler
Employee title
Managing Editor