John Hyland, CFA, is a retired ETF executive and longtime investment industry professional who has contributed articles to ETF.com. He currently sits as an independent director on the board of the Esoterica NextG Economy ETF (WUGI). Hyland also is a director of Matthews International, the investment advisor to the Matthews Asia family of mutual funds.
It is no secret that the ETF industry is having a heck of a party. In the last 15 months, ETFs have brought in $900 billion in new flows, while equity mutual funds in the U.S. had outflows of almost the same amount.
And now we just saw a major investment firm take a giant step to be in this party in a big way.
Last week, Dimensional Fund Advisors converted four of its open-ended mutual funds into ETFs and has two more funds slated to convert in a few months.
Although not the first mutual-fund-to-ETF conversion, Guinness Atkinson converted two funds in March and Adaptive Investments converted one in May. What differs here is the scale of the conversions. While those three mutual funds converted held less than $200 million in assets, the four DFA funds hold almost $29 billion in assets.
Top ETF Issuer Overnight
One of the immediate impacts of these conversions is that it vaults DFA from being the 50th largest ETF issuer—it already had three existing ETFs with $1.6 billion in AUM—to now being the 13th largest issuer, with seven ETFs and more than $30 billion.
In a business where scale matters—most money flows to the largest players—DFA has achieved that spot with a single bold move. DFA is now a legitimate “ETF party animal.”
DFA’s action will likely go a long way in making the mutual-fund-to-ETF process appear to be a much more legitimate strategy for large investment firms to contemplate. The earlier conversions by Guinness Atkinson and Adaptive just don’t carry the same impact as having a giant firm—DFA manages over $600 billion—undertake the move.
Last year, ETF.com ran an article discussing the legal steps necessary to make such conversions (Read: How Mutual Funds Convert To ETFs). In that article, Tom Conner, a veteran securities attorney at Vedder Price, discussed two different ways of doing a mutual fund to ETF conversion.
After Monday’s DFA conversion, he said, “The recent DFA conversion was structured in accordance with the second option we discussed in your last article—assets from several portfolios in the company’s existing mutual fund trust were moved to newly formed portfolios of the company’s ETF trust. Vedder Price has engaged in discussions with mutual fund complexes regarding the mechanics and regulatory requirements applicable to a mutual fund/ETF conversion.”
Who’s Next? Plenty Of Suspects
So, mutual fund companies are talking to their lawyers. This leads to an obvious question: Who is next?
In considering that question, it is helpful to think about who is big in the mutual fund space but NOT big in the ETF space. The number of those firms is actually surprisingly high.
Of the 25 largest mutual fund families in the United States, which all manage hundreds of billions of dollars, if not trillions, only seven also has more than $10 billion in ETF assets. With the DFA conversion, that number is now eight.
The other 17 mutual fund firms either have no ETFs whatsoever, or they have not achieved any sort of real scale with the ETF offerings they do have. Among the names of giant mutual fund firms with no ETFs, or very small lineups, are such well-known names as American Funds, Dodge & Cox, Columbia and T. Rowe Price.
Slow To Move
It is hard to understand why some big firms have not moved sooner to offer ETFs. After all, the SPDR S&P 500 ETF Trust (SPY) was launched almost 30 years ago, and assets in ETFs in the U.S. crossed the $1 trillion mark over 10 years ago.
All of these firms already manage hundreds of billions of dollars, so it is unlikely they are resource constrained. So, while the ETF world is having a party, many of these firms are staying home and hoping investors keep coming to the dying mutual fund party.
For other firms, scale has simply eluded them. Franklin Templeton launched its first ETF in 2013, but has still not crossed the $10 billion mark, even if you combine its ETF assets with the Legg Mason ETFs now that the merger is complete. So, what is a firm to do?
The biggest players in the mutual fund and ETF space tend to be firms that got in early—firms like Vanguard and PIMCO. Since you cannot turn back the hands of time, another way is to buy a place at the table as Invesco did when it bought PowerShares, or Mirae did when it bought Global X.
Slim Acquisition Prospects
But the supply of large ETF firms to try and acquire is very limited. No more than two or three big players are not already owned by another giant financial firm.
Finally, some relative latecomers who have achieved scale—like Northern Trusts’ FlexShares—received a lot of their ETF money from existing assets within their overall organization.
For the mutual fund holdouts, the choices are buying a major player or launching funds and feeding them with a lot of “house money.” But there’s a third option—convert some mutual funds into ETFs and do so with enough scale that you now matter.
It seems logical that the mutual fund players most likely to actively consider making such conversions are the ones who have already entered the ETF space but who have failed to bulk up—firms like Franklin Templeton, T. Rowe Price and Columbia.
The problem all of these mutual funds face is in part based on demographics. Investors under the age of 30 are not coming to the mutual fund party; they are going to the ETF party. Investors under the age of 40 are not going to go to the mutual fund parties in the future. They also want to go to the ETF party.
Ten years from now, you can see a very difficult time for pure mutual fund companies.
All the other mutual fund firms that continue to wait idly by are running the risk of throwing a party nobody wants to come to anymore.
John Hyland can be reached at [email protected]