Mutual fund to ETF conversions: challenges and considerations

June 25, 2024

The market is shifting away from traditional mutual funds toward exchange-traded funds (ETFs). If you’re thinking about transitioning assets to an ETF, here are some of the items you should consider.

ETFs continue to corner the registered fund market and currently hold around $11.5 trillion in assets globally, according to PwC. Over the last decade, “the number of managers offering ETFs has more than doubled.”

In this environment, many managers are converting mutual funds and moving internal assets to ETFs. “More than 70 mutual funds have converted to exchange-traded funds since early 2021,” says a report in The Street. A major reason so many funds are making this move is for potential benefits such as reducing operational costs and increasing flexibility, tax efficiency and investor interest.

As this type of transition becomes more popular and accessible, there are several key factors you should consider as you determine whether it’s the right option for your fund. While not comprehensive, the questions below offer a good place to start:

1. What’s my shareholder composition?

  • Are there taxable accounts that would benefit from a more tax-efficient ETF structure?
  • Are there retirement plan accounts prohibited from owning an ETF?
  • Is there a consolidated shareholder base that would necessitate support from key shareholders?
  • Are there direct shareholder accounts with the transfer agent that would need to be transferred to brokerage accounts prior to converting to an ETF structure?

2. Will I need shareholder approval via a proxy?

  • Do the mutual fund’s governing documents or state law require shareholder approval?
  • Would the mutual fund’s board be comfortable proceeding without shareholder approval, if permitted?
  • If shareholder approval is required, how difficult would it be to secure the vote?

3. How suitable is the ETF structure?

  • Can the mutual fund’s current investment objective, strategies and policies be met within the ETF operational and regulatory structure?
    • If not, can they be modified as part of the conversion to meet ETF requirements without negatively impacting current shareholders?
  • Is there enough expected volume to maintain the interest of market makers?

4. Are my current board and service providers experienced with converting mutual funds to ETFs and supporting ETFs generally?

  • Does the board include individuals knowledgeable about ETFs?
    • If not, are resources available to educate them as necessary?
  • Does my legal counsel have significant experience with ETFs?
  • Does my compliance team have experience with matters unique to ETFs?
    • (For example, are they familiar with Rule 6c-11 (the ETF Rule) and exchange listing standards?)
  • Does my distributor have experience with Authorized Participant agreements and relationships?
  • Should I use the conversion as an opportunity to seek out new service providers?
  • Would my ETF benefit from the resources available in a multiple series (shared) trust?

5. How will a transition impact fees?

  • Will the conversion reduce fees for shareholders?
  • Will the management fee need to change to compete with a new peer group?
  • Will the fund maintain its traditional mutual fund fee structure or adopt an all-in unitary fee structure common to ETFs?
  • What new or different marketing and distribution costs will the adviser bear?

6. How prepared are we to manage an ETF?

  • Does the adviser have personnel with ETF experience?
  • Are compliance and operational policies and procedures ready for an ETF?
    • (For example, has the adviser adopted Rule 6c-11 or basket creation policies?)
  • Will the adviser benefit from engaging a trading sub-adviser to support the portfolio management and basket construction process?
    • If so, would adding a new sub-adviser require shareholder approval?

Draw on available ETF expertise

One of the benefits to partnering with an experienced service provider is that you have support and resources – both to help you make key decisions and to implement your mutual fund-to-ETF conversion if that’s the course you choose to pursue.

When you involve a strong team of seasoned experts, they can assist you every step of the way. They’ll guide you through the benefits, risks and strategies surrounding ETFs. They’ll evaluate your specific fund and help you identify what converting would require from your fund’s board and shareholders. And they’ll break down potential ETF advantages like intraday liquidity, transparency, tax benefits and more. With the right partner by your side, you can make decisions for your fund with confidence, knowing that key details have been considered.

At U.S. Bank, we provide professional and independent facility and security agency services for credit facilities. As an active member of the Loan Market Association (LMA), and a leading CLO and credit fund loan administrator, we have experience with a diverse range of loan and bond financing structures such as syndicated issues, club deals, successor agency, unitranche and bridge financing.

From product development and structure to implementation and ongoing servicing requirements, we’ll walk you through the milestones, challenges and opportunities the world of ETFs has to offer. Contact us or visit our website to take the next steps in exploring your fund growth options.

Learn about U.S. Bank

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