Fidelity Investments recently announced plans to convert six actively-managed thematic mutual funds into active equity exchange-traded funds (ETFs) by the middle of next year. While the asset manager already has nine active ETFs with about $720 million in assets, the new thematic funds would be the firm’s first mutual funds to ETF conversions.
Let’s look at Fidelity’s new funds and the broader mutual fund to active ETF conversion landscape.
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Fidelity’s New Thematic ETFs
Fidelity plans to convert its disruptive mutual funds. Launched in 2020, these funds invest in innovative business models, emerging industries, and technologies that are changing the status quo. As of September 30, 2022, the funds had about $430 million in total assets under management, potentially bringing Fidelity’s total active ETF assets past $1 billion.
The following six mutual funds will be converted to their ETF equivalents:
- Fidelity Disruptors Fund (FGDFX)
- Fidelity Disruptive Automation Fund (FBOTX)
- Fidelity Disruptive Communications Fund (FNETX)
- Fidelity Disruptive Finance Fund (FNTEX)
- Fidelity Disruptive Medicine Fund (FMEDX)
- Fidelity Disruptive Technology Fund (FTEKX)
According to the company’s regulatory filings, the new ETFs will have a modest 0.50% expense ratio in line with the industry average and lower than the previous mutual fund’s 1% expense ratio. And all of the converted funds will be run by the same portfolio managers, meaning investors will have access to the same strategies and experience.
Following a Broader Trend
The rise of mutual fund-to-ETF conversions follows the SEC’s 2019 decision to eliminate the need for separate approval of each conversion. Fidelity’s conversions follow in the footsteps of Dimensional Fund Advisors, JPMorgan Chase, and other asset managers transitioning billions of dollars worth of assets.
According to Bloomberg Intelligence, more than $1 trillion worth of mutual fund assets could be converted into ETFs over the coming decade, providing a massive boost to the $6.5 trillion ETF market.
Mutual funds are steadily losing market share to ETFs. Source: Morningstar
Mutual funds have steadily lost market share to ETFs since 2012. That’s because many older investors are drawing down their mutual fund-heavy portfolios in retirement. And at the same time, younger fee-conscious investors are more prone to use robo-advisors (leveraging ETFs to build portfolios) or construct their own portfolios.
Passively-managed funds have captured market share from actively-managed funds over time. Source: Morningstar
The transition from actively-managed to passively-managed funds has also influenced mutual fund-to-ETF conversions. Since actively-managed funds typically have higher fees, they’re most vulnerable to losing the market share to lower-cost active ETFs. Therefore, it’s not surprising that most conversions have involved active strategies.
Why Undergo a Conversion?
ETFs are usually more tax-efficient than mutual funds. While both are subject to the same capital gains and dividend tax, ETFs have fewer taxable events due to their underlying structure. As a result, investors have an apparent reason to prefer ETFs over mutual funds.
Mutual funds must constantly rebalance to maintain asset allocations or accommodate redemptions. And the sale of securities creates a capital gain for all shareholders. As a result, you could have an unrealized loss on your mutual fund shares and still owe capital gains tax!
On the other hand, ETFs manage inflows and outflows by creating and redeeming creation units – or baskets of assets that approximate investment exposure. That means shareholders don’t typically experience capital gains on any individual security in the underlying structure.
But why would fund managers take a haircut on fees and convert their top actively-managed mutual funds to ETFs?
Mutual fund-to-ETF conversions enable asset managers to maintain their performance track record and retain existing shareholders through the conversion. In addition, ETFs are cheaper to run and easier to sell than mutual funds, potentially translating to a larger asset base.
Finally, new ETF rules permit mutual funds to launch semi-transparent ETFs and active non-transparent ETFs. As a result, asset managers concerned about disclosing their holdings in real time can protect their strategies and still compete in the ETF universe.
The Bottom Line
Fidelity’s plans to convert its disruptor mutual funds lineup to actively-managed ETFs dovetails with a broader industry trend. Beginning with actively-managed funds, asset managers are proactively converting mutual funds into more tax-advantageous ETFs to better align their goals with shareholders and, ultimately, better compete in the future.
Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.
