ETF 101: Mutual Fund to ETF Conversion

Clients expect advisors to know so much about the financial industry, from tax rules to dividend payout schedules. With so many obligations, advisors may not always find time for deeper education. One topic that does merit advisors and investors of all kinds to stop and learn, however, is the mutual fund to ETF conversion process. With ETFs, especially of the active variety, coming on so strong in the last year, it’s an important process to understand.

See more: Fidelity Investments Climbs the Active ETF Ranks

Per Fidelity Investments, since March 2021, 70 mutual funds have converted to ETFs. So why might mutual fund managers convert their funds into ETFs?

Mutual fund to ETF conversion offers some notable potential benefits. ETF popularity is growing, with the wrapper designed for greater tax efficiency and transparency appealing to investors. What’s more, converting a mutual fund to an ETF retains the strategy’s track record. This is a meaningful data set for managers and investors alike. Furthermore, ETFs offer daily trading and may even offer potentially lower fees than mutual funds do.

The Conversion Advantages

Once converted to an ETF, a fund can take advantage of tax benefits afforded by the creation and redemption process. ETFs typically do not pay out capital gains annually, providing the potential for increased tax efficiency. Conversion starts when a fund manager notifies the fund’s existing investors that they plan to convert. After that, the fund manager does almost all the work getting approval from the SEC.

In practice, that means investors’ ETF shares are held in brokerage accounts. Once the fund’s managers receive approval and the rest of the process completes, the fund’s assets move to the ETF wrapper without incurring tax costs.