Mutual fund to ETF conversions pose difficulties, Deloitte finds #NewsMarket

Mutual-fund-to-ETF conversions have become a way for asset managers to refashion investment offerings for investors, but they can be lengthy and arduous processes, a new study has found.

Operational risks, such as constraints and logistical issues, pose challenges to asset managers looking to convert mutual funds, according to the recently released 2025 Investment Management Outlook from Deloitte.

These obstacles include brokerage account requirements, distribution channel arrangements and issues relating to managing fractional shares, the report stated.

There has been a total of 119 conversions, according to data from Morningstar.

This article was previously published by Ignites, a title owned by the FT Group.

The first one, led by Guinness Atkinson in 2021, was initially viewed as a revolutionary development that would galvanise the industry’s move towards ETFs and away from mutual funds, said Alex Alberstadt, counsel in the investment management group for Seward & Kissel, LLP, who worked on the conversion.

“At the time, they were looked at as a clean process. It felt like there were not all these bells and whistles and extra layers of costs,” Alberstadt said.

However, “there are operational issues that everybody has to be up front about, and when you plan a conversion, you have to manage through these issues,” she said.

More than $60bn in assets have been converted from mutual funds into ETFs, according to the Deloitte report.

Firms such as Dimensional Fund Advisors, Fidelity and JPMorgan dominated the flows across the conversions through April, Morningstar data shows.

A spokesperson for DFA declined to comment when reached.

Fidelity has recently filed to convert two municipal bond funds into ETFs next year, according to regulatory filings. Once the conversions are finalised, Fidelity will have completed 14 in total, according to Morningstar data.

“Fidelity believes the conversions will provide multiple benefits for investors of the fund, including lower expenses, additional trading flexibility and increased portfolio holdings transparency,” the manager said in a Q&A on the conversions published on its website last week.

A spokesperson for the manager did not respond to a request for comment on operational hurdles it has faced in the conversion process.

But analysts agree with Deloitte’s findings.

“There’s a lot of work in the background that goes into making these conversions go smoothly . . . If you’re going to do it, it has to be done right so that your clients have a simple experience,” said Dan Sotiroff, a Morningstar analyst.

“Conversion is usually for smaller funds and can be a distribution strategy as much as it is a marketing strategy. Companies can use them as a way to get flows, but that doesn’t necessarily pan out,” Sotiroff said.

As of September 30, year-to-date net flows into the mutual funds converted into ETFs stood at roughly $11.2bn in assets, according to Morningstar data.

And because clients need access to brokerage accounts to hold ETFs, conversions can be issues for firms whose clients do not use them. They can include clients’ holding 401(k) plans that do not typically use ETFs, according to Sotiroff.

“At a high level, you have to make sure your clients can actually hold the ETF — and that’s just the start,” Sotiroff said.

Fractional shares also present issues, because they are available for mutual funds but not for ETFs.

Mutual fund fractional shares must be redeemed at the net asset value of the strategy during a fund conversion, but timing is a factor, Alberstadt said.

Because ETFs do not issue fractional shares, mutual fund shareholders who want to redeem before a conversion may incur additional taxes when those shares are sold.

That information must be communicated to clients and service providers in a succinct manner, Alberstadt said.

“The issues on fractional shares all have to be planned out. There’s multiple intermediaries at the table, and it requires resources and attention,” she explained.

Firms must post a transaction review and ensure that the process was managed properly, she said.

Some of the operational challenges of conversions could be mitigated by regulatory approval of the dual-share class fund structure that was long-patented by Vanguard, Alberstadt and Sotiroff both said.

An ETF share class option would be a favourable alternative to conversions, Karin Risi, a Vanguard managing director of the firm’s strategy, product, marketing and communications, said during a panel discussion at the Financial Times Future of Asset Management conference held in New York.

The conference was co-sponsored by Ignites.

“In the instance where you have the multiple share class opportunity, you don’t need to go through the much more cumbersome and operationally intense process of converting a mutual fund,” Risi said. “Adding an ETF share class onto a fund is a cleaner process.”

*Ignites is a news service published by FT Specialist for professionals working in the asset management industry. Trials and subscriptions are available at ignites.com.