Speaking with ETF Express in March, Brian Barish, a fund manager with Cambiar commented on the Vanguard solution which allows the creation of an ETF share class of an existing 40 Act mutual fund.
Cambiar’s Barish discusses recent launch of Aggressive Value actively managed ETF
He also mentioned that the Vanguard solution comes out of patent in May 2023, commenting that there may be a new range of hybrid products arriving on the market.
February had seen the US’s Perpetual Group file with the SEC to hopefully launch exactly that – the ability to establish ETFs as a share class.
However, the original Vanguard product was based on a traditional passive index fund, whereas Perpetual hopes to launch active funds with both ETF and mutual fund share classes.
Discussing this in detail, Ben Slavin, Global Head of ETFs, Asset Servicing at BNY Mellon, joined Doug Yones, head of exchange traded products NYSE, Morrison C Warren of Chapman and Cutler and Perpetual’s COO Rob Kenyon for a podcast.
ETFs as a share class
Slavin commented on the existing, and growing, business of converting mutual funds to ETFs in the US. He told the audience that BNY Mellon has double digit conversions in the pipeline. Since the first conversion happened in March 2021, close to mutual funds have become ETFs since the first switch in March 2021, representing assets of about USD40 billion.
Last year, ETF Express spoke to Kelsey Mowrey, President, Motley Fool Asset Management, who detailed some of the finer details of their conversion in December 2021 when the firm converted its mutual funds into ETFs and became a full ETF shop, with about USD1 billion in ETFs from converted mutual funds (and total AUM of USD1.5 billion).
Motley Fool’s Mowrey celebrates post conversion and launch of new products
Mowrey explained that the process of conversion was not smooth. “It was certainly bumpy as we were one of the first to convert, which meant it was not just the first for us but also for all of our partners, so we were really learning and taking step backs throughout the process. It was a learning curve for all of us together.
Motley Fool Asset Management, given its affiliation to the heavily retail The Motley Fool site, inevitably had a large direct shareholder base, with many shareholders owning their shares directly and not through brokerage accounts.
That shareholder group was harder to get onto the conversion path, Mowrey explains. There were at the outset some 6-7,000 long term direct shareholders. “This process was a lot trickier, and we had to learn and pivot as we went with them,” she said.
Slavin sees salvation from these issues in the new potential structure. “The ETF share class opens up a new path to market entry…conversions can create frictions for shareholders and this sidesteps some of the issues,” he says.
Does the potential arrival of a new route to combining mutual fund and ETF investors together spell the end of the ETF conversion trend? Slavin doesn’t think so, saying: “My expectation is that the mutual fund to ETF conversion trend will continue, but early asset gathering results and complexity for asset managers may limit the acceleration of this trend.”
The issue has also arisen in Europe, where April saw HSBC Asset Management announce the name changes of four HSBC Fixed Income index funds as it prepared to launch new ETF share classes, designed to provide investors with access to both listed and unlisted share classes through a single fund.
HSBC Asset Management renames four index funds ahead of the launch of new ETF share classes
The funds have been renamed ‘UCITS ETFs’ in accordance with regulatory requirements in Ireland and benefit from a dual ETF and unlisted index fund structure. The firm wrote that the issuing of the new share classes ‘will meet growing investor demand for flexibility, by offering listed and unlisted share classes through a single fund in a move designed to increase investor choice. The move will allow clients that prefer ETF structures to access funds with significant assets under management (AUM) and a strong track record.’
Stephen Carson, partner at A&L Goodbody, comments that 2018 saw the Central Bank of Ireland update their UCITS framework to allow ETF and non-ETF share classes in the same sub-fund and that HANetf have been structuring their ETFs in this way for a number of years.
The HSBC development is significant because they added ETF share classes into their unlisted UCITS funds.
There is a further anomaly in the regulations which means that the ESMA guidelines require the ETF issuer to use the “UCITS ETF” identifier in the name of the fund. “If you think of a large unlisted sub-fund adding an ETF share class, it is anomalous to have to change the name of the fund,” Carson says. “ESMA is aware of this and hopefully it is something that they might look at in the future. In the meantime, it is something which a traditional UCITS fund manager who wanted to launch ETF share classes in an unlisted fund, would have to take into account.”
Carson also noted that HSBC listed fixed income sub-funds as ETFs, rather than equity funds. This is significant because an issuer with listed and unlisted share classes which have US equity exposures would have to have a process to monitor the level of trading activity in the funds to ensure that the level of trading would not fall below the threshold required to access the treaty benefits.
Another angle to this new development that Carson points out is that the overseas fund regime in the UK hasn’t started yet, restricting the ability to register new ETF platforms for sale in the UK. However, if it is an existing fund that is now offering an ETF class and has the benefit of the temporary marketing permissions regime, it’s good to go.
“I think it will create another avenue for non-ETF managers to dip their toe into the ETF market,” Carson says.