Q&A: Why This Asset Manager Is Converting Mutual Funds to ETFs

Exchange-traded funds, or ETFs, have yet to reach their 30th birthday, yet their market share has seen remarkable growth. Since the first ETF debuted in 1993, the ETF market has grown to more than 1,670 ETFs, accounting for $5.1 trillion in net assets at the end of last year.

Financial advisors and investors are increasingly favoring ETFs over mutual funds for their relative lower cost and tax-efficient nature. As demand rises, fund providers are racing to keep up. They can increase supply in one of three ways: by issuing more shares of existing ETFs, creating entirely new ETFs or converting existing mutual funds to ETFs.

Dimensional Fund Advisors, a global asset manager, was one of the first managers to convert some of its mutual funds to ETFs.

In the largest such conversion to date, the company recently converted four of its U.S. mutual funds to ETFs, making Dimensional one of the largest global active ETF issuers in the industry with about $30 billion in combined ETF assets under management.

We spoke with Althea Trevor, head of equity portfolio strategists and vice president at Dimensional Fund Advisors, about this conversion and what it means for financial advisors and investors. Here are edited excerpts from that interview.

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What prompted Dimensional’s decision to pursue these conversions?

We’ve been watching the ETF landscape for many years. We’ve witnessed the evolution in that space and now we believe we can bring Dimensional’s active implementation into an ETF structure.

If we can offer a similar strategy in different vehicles, we’d like to offer our clients that choice.

[READ: Will More Advisors Shift Client Assets From Mutual Funds to ETFs?]

What are the main benefits of converting these mutual funds to ETFs?

There are four benefits to converting the tax-managed mutual funds to ETFs.

First, improved tax efficiency. Converting to an ETF structure can provide benefits with respect to the management of capital gains distributions, allowing for potentially greater tax efficiency for the funds.

Second, each reorganization will result in significant management fee reductions, representing a 27% average reduction on an asset-weighted basis across the converting funds.

ETFs also trade with no transaction fees on many platforms.

Lastly, shareholders will not recognize a taxable gain on the conversion of the mutual fund to ETF shares for U.S. tax purposes.

[Read: Financial Advisors Eye Biden’s Plan for Estate Taxes in 2021.]

What differentiates Dimensional’s solutions from indexing products, which represent the vast majority of ETF assets in the market?

We believe these strategies fill a unique space in the ETF market, combining the benefits of passive investing, including low-cost diversified exposure to stocks, with the advantages of active investing, such as higher expected returns, flexible trading, robust daily portfolio management and risk management.

While the ETF marketplace is established, the vast majority of existing funds are index solutions: 98% of ETF equity assets and 96% of total ETF assets are in index solutions. We are still very early in the development of the active equity ETF space.

While an index fund is a good starting place for portfolios, investors may be leaving money on the table by missing out on the increased return potential of more strategic management, such as daily rebalancing, flexible trading, securities lending and adept tax management.

What plans do you have going forward in the ETF space?

After debuting our first ETFs in 2020 and converting four mutual funds to ETFs in 2021, we expect to continue expanding our ETF lineup in line with client needs. We have previously announced plans to convert two additional non-U.S.-market, tax-managed mutual funds to ETFs in September 2021 as well as filing an initial registration statement for four fixed-income ETFs.

What role would the four new ETFs play in a client portfolio?

Dimensional ETFs provide a range of equity solutions that include marketwide equity portfolios with varying degrees of emphasis on drivers of expected returns, as well as component solutions such as value and small-cap portfolios.

We believe this range of strategies provides the building blocks to customize an asset allocation, helping financial professionals meet the specific investment goals and needs of their diverse investor bases.

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Q&A: Why This Asset Manager Is Converting Mutual Funds to ETFs originally appeared on usnews.com

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