Why some active mutual funds will never be ETFs
OWhile the number of new actively managed ETFs coming to market has nearly tripled since the Securities and Exchange Commission made significant rule changes in 2019, the limitations brought by Rule 6c-11 and the management activity of the money have stopped many managers from issuing ETF versions of their successful mutual funds.
One of the reasons why popular and profitable mutual funds may never see ETF versions is that it is simply not profitable for the manager to convert them. With fee compression, an equivalent ETF could eat away at a manager’s more profitable mutual fund business.
“The ETF market is more competitive than the mutual fund market. Asset managers need to price their versions of ETFs competitively,” Todd Rosenbluth, head of research at ETF Trends, told Barron’s. “There is a legitimate fear of cannibalization.”
Regulatory and investment reasons have also prevented managers from issuing ETF versions of their popular mutual funds. The 2019 rule changes allow active managers to manage their ETFs in semi-transparent portfolios that hide some of their holdings from investors.
But the rules for semi-transparent ETFs are more restrictive. The securities of these ETFs trade on public exchanges simultaneously with the funds, which mitigates the risk of price irregularities. However, this means that most foreign stocks are excluded, as domestically traded ETFs may have difficulty pricing them accurately when foreign exchanges in different time zones are closed. Bonds that trade in private over-the-counter transactions are also excluded. Some illiquid domestic small caps that do not trade regularly could also be a problem.
And with the way the current regulatory system is structured, some mutual funds will never operate as semi-transparent ETFs. The hugely popular T. Rowe Price Capital Appreciation Fund (PRWCX) not only owns bonds and preferred stocks, it’s also closed to new investors, something an ETF can’t easily do.
Scott Livingston, head of ETF strategy at T. Rowe Price, told Barron’s that the semi-transparent structure can work with small caps, but “there are other considerations for a large manager like us around capacity.” . A fund like the T. Rowe Price Small-Cap Value (PRSVX), for example, already faces capacity constraints.
Livingston also noted that Wall Street is struggling to work with closed ETFs as the supply of new stocks is cut off.
Yet, T. Rowe Price offers a suite of actively managed ETFs. T. Rowe Price has been in the investment industry for over 80 years conducting hands-on research with companies, utilizing risk management and employing a multitude of experienced portfolio managers averaging 22 years of experience .
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.