Mutual fund conversion to ETFs in the US has been one of the most interesting phenomena to appear from the ETF rule change, with billions in assets added to ETFs which either mirror or replace their mutual fund cousins.
Ben Morris, product manager of Bloomberg’s BSKT solution, comments that it is fascinating at the highest level to see this development of acceptance of the ETF structure, against two or three years ago, where, he says, there was more skepticism around ETFs. “Now there are going to be more people getting into this space and more conversions happening, with almost no hesitation – just launch the product in an ETF wrapper. The lack of distress around ETFs during the market turmoil in March 2020 also bolstered people’s confidence in ETFs.”
Morris believes that it’s the transparency of ETFs that has contributed to their increased popularity.
“The challenges for clients and where people are focused on making a transition work seamlessly has historically been around the operational aspects of ETFs,” Morris says. “Senior portfolio managers are managing their assets with the same investment intent in different structures, and they might have one theme across them all, but the ETF is more demanding because of the create and redeem process, and that is the biggest concern from a compliance and risk perspective.”
Morris reports that many clients are coming to Bloomberg to see how the BSKT solution works. BSKT is a primary market solution for negotiation, ticketing and routing ETF creation and redemption transactions, and is used by ETF issuers, market makers, authorized participants, distributors, custodians and institutional investors.
“People are coming to us for help to adopt some of the standardisations and best practices within BSKT,” he says. “We are starting to see conversions of mutual funds to ETFs, but also traditional mutual fund shops are coming into this space. They either seed overnight with a ton of assets or are coming to the market with new products in ETFs rather than in the mutual fund structure.”
Morris employs an extended and interesting metaphor in describing his clients’ feelings as they approach the ETF world, drawn from the days when he worked at a restaurant.
“If you are a chef, your main job is to respond when someone orders a meal. You have the order details from your client, you know the volume you will be required to hand over and there is a certain degree of predictability. This is similar to managing a mutual fund or a separately managed account. It’s very predictable and you know the number of assets.”
Morris comments that some asset management firms are focused on the high touch products creating a special experience for their clients.
“So, you put the ETF order in and it’s like you’ve opened a takeout window from the side of the kitchen. You have a new workflow but no predictability,” Morris says. “Volumes can flood through the new window but BSKT can help keep the new workflow orderly and under control.
BSKT has a particular strength in the fixed income markets which work differently from equities. Morris says: “Since fund managers optimise the index in their portfolios, they also need to optimise each create and redeem basket. The increased indexification of fixed income as an asset class means more clients are looking for solutions for these workflows, which is where BSKT adds value.”
Morris comments that big institutions are using these passive products because they are hyper efficient and very liquid.
“They are also becoming more sophisticated and more granular like we have seen in the equity markets, with a lot more specific funds, indices and investment themes which will continue with big shops pushing into the fixed income marketplace.”