Mutual Fund to ETF Conversions

In response to investor interest in the exchange-traded fund (ETF) vehicle, firms are rolling their existing assets from another product (usually a mutual fund or separately managed account) into an ETF to kickstart their ETFs. Rule changes and regulatory guidance have also laid the foundation for conversions prompting interest by asset managers.

However, converting a mutual fund to an ETF is not a straightforward process, and it is important that firms do their due diligence when considering such a move and assess time, costs, and the changing product landscape.

What needs to be considered?

This complicated undertaking will require commitment across an organization. The first course of business is to set a realistic timeframe that reaches beyond regulatory approval to manage this in-depth event. The framework will help organize your understanding of the various considerations and guide the decision of whether converting a mutual fund to an ETF makes sense for your firm.

The framework consists of three pillars.

Strategic analysis

• Determine if the investment strategy can be supported in an ETF. Assess if transparency of an active ETF is acceptable for the strategy, or if there are concerns around immediate disclosure of intellectual property that is prompting the need to evaluate exemptive relief options utilizing a semi-transparent ETF wrapper.
• Understand if an ETF wrapper makes sense for the type of investors or programs the mutual fund is in to alleviate loss in transition.
• Review the requirements of onboarding and ongoing support of ETF products at intermediaries (secondary market), discussed in further detail later.
• Acknowledge that ETFs do not soft or hard close. The creation/redemption mechanism is required to confirm that the arbitrage mechanism works. Evaluate the capacity constraints of contemplated strategies.
• Review the share class structure of the mutual fund to determine if collapse of multiple classes into one is the best process to move forward.

Governance

• Conversion mechanism - Think through which type of conversion mechanism to use. Either reorganize the existing mutual fund or merge it into an ETF. Determine whether to file a registration update that states the date that the fund will be offered as an ETF or that the merger will occur. When considering mergers, decide whether to fold the mutual fund into a new shell ETF or an existing one.
• Governing documents - Review governing documents to determine if your trust permits you to offer ETFs and to understand if a shareholder vote is necessary.
• Board approval – Keep your board fully informed throughout the entire process regarding how the conversion will impact shareholders

Compliance and operational considerations

• Comply with ETF-specific rules, such as the Securities and Exchange Commission’s (SEC’s) ETF Rule for active transparent ETF structures or conditions of that relief for a semi- or non-transparent structure.
• Ensure the ETF’s compliance program addresses new entities that the fund encounters in the ETF ecosystem, such as authorized participants, website vendors, and ETF - specific data providers.
• Fractional shares – ETFs are measured in units, but mutual funds are measured in dollars.
• Shareholder accounts – ETFs are held in a brokerage account. For any mutual fund direct clients, a brokerage account would need to be established.
• Focus on new and existing service provider relationships.
• Changing intermediary relationships - Although the traditional mutual fund dealer agreement ecosystem does not apply to ETFs, the relationship between the ETF asset manager and intermediaries still exists.

Weaving this all together

• The ETF Rule and regulatory guidance have laid the foundation for mutual fund to ETF conversions.
• Continued investor adoption and market flows in ETFs are signaling that the timing might be right for firms looking to enter the market with a conversion that allows firms with existing products to bring assets and a track record into the ETF structure.
• The ETF ecosystem requires a cultural shift for firms requiring them to embrace new roles, implement new workflows, and educate stakeholders.
• Implementation of the conversion framework (strategic analysis, governance, operational reviews) will provide the necessary infrastructure to evaluate if a conversion makes sense.
• Set expectations internally and externally to ensure the organization and its’ service partners understand the scope of the proposed conversion project and are committed to its success.
• The scope of the conversion project will touch all aspects of your business and relationships.
• Early and ongoing communication is necessary for success.

Ready to launch an ETF?

If you are looking to launch an ETF, then download our guide below. We will walk you through everything you need to know to get started, including the differences between ETFs and other product offerings, startup costs, necessary service providers, and how to gain assets via distribution.

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How we help

If you are ready to launch an ETF, then contact us today to get started. Year-over-year, the most well-known global wealth and asset managers continue to choose ACA Foreside to help expand and support their product line up of ETFs. In 2023, our specialists partnered with more than half of the ETF launches in the U.S., and we support 1,000+ ETFs distributed across 275 managers. 

We work with asset management firms throughout the world to facilitate compliance and product distribution through legal underwriting, registered rep licensing and chaperoning, and DTCC/NSCC fund sponsorship. We have experience working with all types of pooled investment vehicles, such as traditional mutual funds, ETFs, alternative products, closed-end interval funds, and private placements.

Once launched, we can further support you with our broad range of advisory, managed services, and regulatory technology solutions, to help you grow and protect your business, while also addressing your compliance, ESG, investment performance, and cybersecurity challenges.