There have been some very big watershed moments in the world of investing: the Investment Company Act of 1940, the launching of the first index fund, the creation of exchange-traded funds and the first online discount brokerages. These have been some of the defining moments that have shaped the modern investing landscape.
And we’re about to see another one.
Investment bank and asset manager J.P. Morgan recently announced its plan to convert some of its active mutual funds into active non-transparent ETFs. The importance lies in the sheer size of the conversion, and the fact that J.P. Morgan is the first major traditional asset manager to make such a conversion. All in all, it provides credence and confidence in the active ETF model.
For investors, it could mean that more such conversions are on the way.
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$10 Billion In Assets
J.P. Morgan already has several active ETFs in its line up, mostly in the fixed income and cash management sectors. Now it intends to convert four of its large and successful actively managed mutual funds into active ETFs. The four funds represent nearly $10 billion in assets under management:
- JPMorgan International Research Enhanced Equity Fund (OEIAX)
- JPMorgan Market Expansion Enhanced Index Fund (OMEAX)
- JPMorgan Realty Income Fund (URTAX)
- JPMorgan Inflation Managed Bond Fund (JIMAX)
In addition, the conversions will combine the boards of its ETFs and mutual funds into a single common board of 16 members.
In March 2021, the thematically focused Guinness Atkinson became the first fund company to convert two of its mutual funds into ETFs. In June 2021, fundamental indexing specialist Dimensional fund Advisors (DFA) converted four of its funds. DFA funds had long been only available through a select network of financial advisors, while Guinness Atkinson’s thematic approach has long left its funds as “satellite” holdings.
But with J.P. Morgan’s announcement, you now have a significant asset manager with plenty of retirement plan exposure making the leap.
The Benefits for Fund Companies & Investors
The question is why? The simple answer is investor demand.
J. P. Morgan’s Global Head of Asset Management Solutions, Jed Laskowitz, recently said that “Increasingly, we’re watching our clients. In addition to using mutual funds and other vehicles, investors continue to adopt the ETF vehicles and increasingly adopt active ETFs.”
The more complex answer to why investors want ETFs comes down to their structure. Thanks to the creation and redemption mechanism, capital gains on ETFs – from the underlying holdings – are generally zero. When a manager needs to get rid of a holding, they can essentially hand it off to authorized participants via an in-kind transaction. For mutual funds, the manager needs to sell the shares. This triggers either gains or losses for shareholders. As such, ETFs have long been major winners on the tax front versus mutual funds. With tax rates expected to rise, they could be a powerful tax-fighting tool going forward.
At the same time, the intraday tradability of the ETFs allows investors to time movements, gains, losses, etc., to better suit their needs. Better still, they are able to engage in tax-loss harvesting transactions to improve the tax efficiency of a portfolio.
But, arguably, the biggest reason why ETFs have caught on has been costs. With brokerages charging zero on trading commissions and the overall lower expense ratios of ETFs, investors have flocked to the fund type in spades. Numerous studies have shown that high costs are one of the main reasons why investors fail to beat or meet the market. Overcoming this fee hurdle is a major reason for portfolio underperformance.
J.P. Morgan’s Head of Americas ETF Operations, Bryon Lake, perhaps said it best in a statement, “The intraday liquidity, transparency and potential tax benefits that come with ETFs carry significant value to many investors.”
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More To Come With a Few Caveats
While J.P. Morgan could be the watershed moment for mutual fund to ETF conversions, it won’t be the last. Already, T. Rowe Price, Fidelity and Capital Group have all registered for mutual fund-to-ETF conversions, or similar active ETF launches. Investors are simply clamoring for the fund structure in their portfolios, and managers are willing to deliver.
All in all, Bloomberg Intelligence predicts that more than $100 billion in mutual funds could convert this year into respective ETFs. Over the longer term, analysts are a bit rosier with their conversion predictions. Some estimate that nearly one-third of all mutual funds could make the conversion sooner than later.
But not all will. Much of the conversions will come from funds seeking additional tax-efficiency or looking to keep their “secret recipes” hidden for stock/bond selection. For example, Morningstar estimates that funds that are inherently located in retirement plans – like target-date funds – will see no benefit in converting to ETFs. Tax-efficiency is already there.
Check out our comprehensive list of Target-date Funds and explore which one suits you the best.
Meanwhile, more conversions may have the regulatory bodies starting to look at the ETF structure and its tax advantages more closely. Some of the tax advantages of the fund vehicle could disappear down the road.
The Bottom Line
With J.P. Morgan now converting four massive mutual funds to ETFs, the movement is on. We may have hit the tipping point for ETF adoption as a real tool for portfolio construction. Overall, the benefits of ETFs are vast, and it seems that more fund companies will allow their investors to take advantage of the structure.
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