More and more mutual funds are switching to exchange-traded funds, which experts say is a positive trend for investors.
According to Morningstar Direct, there have been more than 70 mutual fund-to-ETF conversions since the start of 2021, including nearly three dozen in 2023, and experts expect more conversions to come.
“It’s steadily increasing year over year,” said Daniel Sotiroff, senior manager research analyst at Morningstar Research Services.
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A 2019 Securities and Exchange Commission change offered fund managers more flexibility, which Sotiroff said helped pave the way for the transition from mutual funds to ETFs.
The conversion itself is tax-free for the investor and they switch from actively managed investment funds that aim to outperform the market. The main advantage of the new ETF is greater tax efficiency.
“That’s a big selling point,” Sotiroff said.
Year-end distributions of mutual fund capital gains can be a hassle for investors with actively managed mutual funds in brokerage accounts. These withdrawals can result in a significant tax burden, even if the investor has not sold any shares.
In 2023, many fund managers realized profits to meet investor redemptions, resulting in double-digit forecast payouts for some funds.
The most attractive feature of an ETF is that most of them do not distribute capital gains at the end of the year.
Barry Glassman
Founder and President of Glassman Wealth Services
Despite the increase in converting mutual funds into ETFs in recent years, it's still “pretty rare to see,” said CFP Matt Knoll, senior financial planner at the Planning Center in Moline, Illinois.
Sotiroff said the conversions were “relatively smaller” actively managed mutual funds worth around $100 million or less, which are more likely to be converted into ETFs.
“You don’t see a lot of big-name mutual funds turning into ETFs,” he said. Exceptions, of course, were the conversions of Dimensional Funds and JPMorgan.
Future conversions are likely to be smaller, actively managed mutual funds outside of 401(k) accounts, Sotiroff said.