That Mutual Fund Has an ETF Now

But because that patent, nobody could do it. But the patent expired a couple of years ago, and so basically like eighty to one hundred mutual fund firms were like, yeah, let's do that. So they all filed and the SEC starting to approve them, and the guinea Pig, the first one out of the gate to do a non Vanguardian ETF share class of a mutual fun is dimensional DFA, and they put it out recently, and it's basically a big moment for the industry. It's wonky, but it's major.

And the reason it's major is because those eighty to one hundred issuers have in the ballpark of ten trillion dollars in assets. So if you're sitting out there and you own a mutual fund and you kind of would rather have it in the ETF format, you might be able to get that without having to sell your mutual fund. You can maybe just move over. There's a lot of options now. And also, at the end of the day, ETFs were the fisher biting trol. It's like Spotify, It's

just how people like to get music. So if you're an asset manager, you definitely want to get your strategy in this format.

of scale right. Because it's one pool of assets, you're able to amortize some of the costs across a bigger pool. You also get more choice because in the past, investors always had to think about what strategy do I want? Is it available in an ETF or a mutual fund? And then, as Eric was referring to earlier, they would have to think about are the costs similar? Because before I used to have pretty different costs for different types

of classes. So hopefully going forward investors can just say what investment strategy do I want, and then it can be available in either way they can consume it as a ETF as a mutual fund for similar prices.

that ETF share. So in the future, are actually starting now with these new share classes, they will be able to convert in a tax free manner to get an ETF share instead of a mutual fund share. I think that's a big problem that solved. A second problem I think is solved is what I was mentioning earlier, which is it was pretty hard to navigate figuring out what investment do I want, how is it offered, and then

how's it priced? Differently, I think it brings a lot of simplicity where you can go get the investment you want in the rapper you want for a similar price.

sort of reshuffling the chairs. And if you're holding let's say that's five s top five hundred in an equal weight format, you're not actually getting additional diversification. You're not gaining access to different exposures. And what this Portfoli folio does is it targets companies that are in the smallest five percent of market cap in the US. And as you said, Katie, it's been around for forty five years. It's had a great track record of outperforming other small

cap funds, other small cap indexes. It's beaten the Rustle two thousand by one hundred and fifty basis points a year annualized for forty five years. So if you compound that, that's just massive wealth creation for our investors. And it behaves differently than the large cap space, and so if you're looking to round out your portfolio and diversify away from being so top heavy, this is a great solution.

So the ETF has the same expense ratio as the institutional class of the mutual fund. So there really is no AB or C classes with a higher fee that you might potentially annoy which I think could be an issue with other funds where you give people the I class fee and the ETF and the ABC people are like, hey, that's not cool. We found that to be somewhat of an inhibitor in some cases with conversions and other things of that sort. But any thoughts on that.

And so for other future ETF share classes in our lineup, I think you'll see something similar right where we're not going to face some of that challenge with multiple pricing points that other managers may face. Another thing that I think you have to be cognizant of is if you're running a more traditional active strategy that has higher turnover, is more concentrated, then that may be more challenging in

an ETF format. Now, you mentioned earlier that the performance of this strategy, the microcap strategy, has been excellent for a really long time period, and you may think that it is doing that in some sort of high turnover active way, but it's not. It's actually broadly diversified, it's

low turnover, it's incredibly tax efficient. Everyone in the ETF ecosystem loves to talk about tax efficiency, and this strategy as a mutual fund was actually more tax efficient than the other small cap index ETFs that were out there. So I think there's it'll depend on the manager and the strategy in terms of what strategies are best to bring in the ETF share class format.

before that had no capital gain distribution. But let's not forget that income also matters, and any investment fund, whether it's ETF mutual fund, can put off two types of income, qualified and non qualified. And qualified income is taxed like a long term capital gain, but non qualified income is taxed like a short term capital gain. So at the highest marginal rate, non qualified dividend income is a forty

point eight percent tax. So that's really toxic. And what our strategies do is they are maximizing the amount of qualified income. So compared to other index ETFs that are out there, if you go look at their QDI percentage, they are putting out a lot more non qualified dividend income that's taxed at a much higher rate. And so the way that any of the listeners would find this information for themselves without having to get too much in

the weeds is start from the highest level. Just open up the perspectus, go to the performance section of any fund or ETF, and there will be a pre tax return and there will be a post tax return, and you just want to compare the difference year by year, and that difference is called the tax cost. And so across the morning Star universe of US small cap strategies, the average tax cost has been over one hundred basis points.

And if you narrow it down to just the biggest small cap index ETFs, that tax costs was still about fifty basis points, whereas this strategy's tax cost last year was only twenty nine basis points, so twenty one basis points better than some of the big index ETFs.

of the punch. But I was recently speaking with Capital Group, for example, about why they didn't file for this exemptive relief, which was pretty interesting, and their point was that the bulk of their mutual fund assets are sitting in retirement accounts, and if you have a mutual fund in a retirement account, it's not as urgent to you know, get the tax efficiency that the ETF offers, since I believe capital gains aren't taxed in the same way if it's in a

retirement account. I'm sure I butchered that somehow. But I wonder how Dimensional sorted through that. I mean, what percent of Dimensional's mutual funds are in retirement accounts and versus you know, how many would be eligible for something like this.

And the types of clients that care about that may be a financial advisor who has both a retirement business and a wealth business, and once they've done the diligence on the strategy and they're like, I really love this investment strategy. I would like to be able to use it for both types of clients. Now, they can, whereas before they were faced with the trade off where they

could only use it in one or the other. But going the other direction, we actually do have some strategies that are only offered in ETF formats right now that we are likely to bring over and offer mutual fund share classes of So we recently filed to do that

for two strategies that we call our market series. And what these are is they're designed to be index replacement strategies, so they have lower tracking air than most of our other more active strategies, but they're designed to outperform, and they have a track record of outperforming. And we have some clients who are using those for their taxable clients in the ETF wrapper, saying we would love to be able to offer those in mutual fund format to some

of our retirement clients. Or we have institutions who are tax exempts saying we would like to have these in another vehicle type, and so we are likely to offer both types of share classes, so then you can get the economies of scale of running one portfolio with two different access points.

the same performance? How does that work?

as a track record that you can rely upon. And in the case of DFMC, the microcap ETF share class, that portfolio has a forty five year track record and so people who come in and do diligence on the ETF share class can look through a ton of history and understand how that portfolio is design and how it's managed, how it's behaved, and that does I think give the ETF share class a leg up over a newly issued ETF, even if it's of sort of a sister strategy.

a supermarket where we offer one of everything. We're really our client is the financial professional, and so we're trying to give them professional grade tools, best in class strategies so they can accomplish the investment outcomes that they need for their clients or their organizations. And what we've heard from all of them, I shouldn't say all, but the vast, vast majority have said we really like this idea of having shared classes, and then the other ones have really

just not said anything. To be honest, I have not heard a negative thing yet. Most of them are very supportive of the idea that there's going to be mutual funds share classes of ETFs and ETF shared classes and mutual funds, and so in terms of what that means for our plans in the short run, we have filed to bring thirteen different US equity strategies to the ETF share Class Rapper. We will likely be doing that through the rest of this year and into the following years.

I think you can probably expect fixed income to follow equity, and then non US markets to follow the US markets, and so we do have a pretty big pipeline in mind. It will be driven by client demand. But if we realize sort of the vision that we're hearing clients want us to realize, and this is a big statement, but I think you'll see us go from being a big mutual fund manager and a big ETF manager. And you know,

we've been the largest active ETF manager. I think we could potentially go to become one of the largest ETF managers period, whether that's active or passive, big words, big words.

interesting to see what happens with you. I think. Do you feel that that there's a lot of people watching you to see what happens or do you think we'll see other launches very quickly even if we don't have any maybe early flows or information from your funds.

this can bring to end clients. Now, do I think that it'll be panacea, that it'll be a universal solution for everybody in that every fund in the industry will also turn into an ETF. Probably not. Not every strategy is well suited to an etf rapper. Right, You've seen the debates already about what can be fit into an etf rapper over on the private side and people dealing

with the lack of liquidity. I think people will eventually run into some limits of what can be put in the etf rapper, even in public markets, and so I think that other managers will have to think through which of their strategies are well suited to the etf rapper, and then it's not one of those situations where if you build it, people will just come. I think it's also important that you spend time talking with your clients to understand is this a solution that they really need.

And what we've done is we've went out. You know, we saw in the first day of trading for DFMC some clients come in and place trades on day one in really large sizes and get great executions inside a very tight spread. So that type of coordination with your clients is key. You can't just sort of toss these things out there in the market and hope that assets show up.

ETFs took in one point five trillion last year. This year they're already on pace to have more than that. This is a big variable. I just think it's going to happen in slow, gradual stages. It's possible it goes gradually then and then suddenly, like if like DFA you know, attracts fidelity and then Capital Group and then we're looking at the big fish of that active world. I think you could find then it's like suddenly. But I think

it will be gradually. If I had to estimate, I don't know, maybe like a couple billion in the first few months and then we'll go to ten billions and then one hundred billion. But I don't know. I think it's going to depend. But here's what I do know, Joel. If you look at the especially equities, equity mutual funds saw a trillion of auflows last year, most ever by far, and the markets were.

process that involves a lot of paperwork. And I think that while that's in place, and we worked really hard to get that in place for our investors, that will cause it to be a slower conversion. As soon as you can log into your broker JAP and there's a button for it and you can move it in a tax free way, I think that you'll see a big increase. And so right now we're expecting that to be later

in this calendar year. But as soon as that happens, then I think you're probably order of magnitude closer to Eric's estimate than single digits.

want to look like it's a success story. So I think there'll be some like preparation before, so it looks like they're have a hit on their hands.

the R six or I class. And if they do that, then the ABC people are probably gonna have no reason to stay there. So you couldn't launch this at an A class price point, because I mean, I just don't see it selling an ETF market. So they're going to have to launch it closer to the eye right, and that alone will entice people. Well uh, but will it get new bites from like probably probably not most of them, to be honest with you, A lot of this is a conversion story, But this fun from these guys. The

microcap I mean microcaps are kind of forgotten. Nobody's really in there. There is a if they just launched this straight and it wasn't a share class, I would look at this a little bit. It's interesting, it's it's you know, it's outperformed at least the mutual fund. Has the managers done a good job? Microcaps have been like off the radar. Maybe it could get like a Vanti style in the small cap category. Maybe it could like kick off some

microcap interest. This one has some real market I think potential. But DFA is a great case of like their conversions are all like very low cost. I mean they have low tracking error, but their fee is low, so they have beta adjusted their fees. So I will say the ones that will have the most success are the ones that most beta adjust their fees. DFA is really good at that, so this is JP Morgan. Others not so good. So I think that's where the success and failures will go.

on day one. Luckily, a manager our size and with our reputation in history, we get to work with the A team. We get to work with a lot of the best market makers that are out there. I do think as people start to come into the market, they may not have the depth of relationships with some of those aps and market makers, and then the strategies themselves

may be more difficult to make markets in. I think they're going to have to engage with that community and figure out what's possible, because what you don't want to do is launch a product and then have the end investor have a bad experience. So for us the north Stars, those investors need to have low costs when they trade, so tight spreads, good executions, good liquidity, and that's not something that we would compromise on in products that we

would bring. But I think people are going to have to spend a lot of time thinking through that, because you're right, Katie, there's not unlimited balance sheet available from some of the marketmakers.