Many investors and advisors prefer exchange traded funds because of their lower cost, better liquidity and more transparency. Unlike mutual funds, ETFs tend to have significantly lower expense ratios and trade on an exchange, meaning investors can easily buy and sell them. In addition, ETFs can be shorted, optioned or used in hedging strategies.
There’s also a significant improvement in tax efficiency. When a mutual fund sells securities within its portfolio, it may realize capital gains and distribute them to shareholders – even if the shareholders did not sell any fund shares! ETFs use in-kind redemptions to avoid triggering these capital gains taxes, resulting in superior tax efficiency.
The mutual fund conversion process also enables asset managers to keep their existing shareholders through the conversion. As a result, the new ETF starts with a solid asset base and an existing track record. These abilities enable asset managers to jumpstart their presence in the ETF space without starting over from scratch with a new fund.
That said, not all mutual funds are suitable to be converted to ETFs, and not all fund issuers will benefit from converting their funds to ETFs. Most ETFs require daily disclosures of portfolio holdings, which could divulge competitive information (with the exception of non-transparent ETFs). And the conversion could introduce cost and complexity.