Another strategy that has caught investor attention, he says, is emerging market ETFs that exclude China. When China is included, these markets suffer from that giant’s outsized swings—which have been amplified by the country’s opening of its A shares market to global investors. China’s weighting in emerging market indexes has ballooned to about 30% for that reason.
“That’s fine when China does well, but within the past year China hasn’t done well,” Ullal says. “We’ve seen a lot of interest from financial advisors in strategies that unbundle emerging markets and look at ex-China ETFs like EMXC [the iShares MSCI Emerging Markets ex China ETF.]”
Mutual Funds To ETFs
Passively managed index funds still dominate the ETF scene, but actively managed products are a faster-growing segment (though, granted, they’re starting from a much smaller asset base at less than $500 billion).
“What’s driving this is advisor demand,” says Matt Apkarian, associate director of the product development practice at Cerulli Associates. “Financial advisors like the tax efficiency of ETFs over mutual funds in taxable accounts. ETF use by advisors will increase significantly in coming years.”
Larger numbers of asset managers are energizing the active ETF space by offering equity strategies that either mimic or closely resemble their existing mutual funds. The ETFs typically cost less than the related mutual funds.
Some of these funds use a semi-transparent structure so they won’t have to report their holdings daily, which is something required of traditional ETFs. But that format hasn’t caught on with investors in a big way.
One trend that popped up a couple of years ago involves fund sponsors converting active mutual funds into fully transparent ETFs.
Dimensional Fund Advisors and J.P. Morgan Asset Management have been the biggest players in this nascent movement, which instantly boosted their positions on the ETF leaderboard. Nonetheless, Sotiroff from Morningstar says this trend is more of a trickle than a torrent.
Some managers are also taking a page from Vanguard by creating ETF share classes for their existing mutual funds. Vanguard owned a patent for this dual-share class structure and used the structure for two decades before the patent expired in May. Whereas Vanguard applied this structure to index-based funds, Fidelity Investments in October filed for regulatory approval to create a separate ETF share class for its actively managed funds. Likewise, Dimensional in July sought approval to create a separate ETF share class for its mutual funds.
By creating an ETF share class, asset managers give investors a choice in how they access a particular fund’s strategy. Some financial advisors and investors prefer mutual funds for certain uses, such as in their tax-deferred 401(k) accounts. But the tax-efficient nature of ETFs make them better suited in taxable accounts.
“I wouldn’t be surprised to see more filings coming for creating a separate ETF share class for existing mutual funds,” Sotiroff says. “There are some funds where it makes sense to do that and others where it doesn’t make sense.”
Ultimately, active managers realize that their mutual fund franchises are under attack, and for some of them the response is, “If you can’t beat ’em, then join ’em.”
“Interest from asset managers in ETFs is the simple fact that they have to play this game,” Sotiroff says. “A lot of this is active managers trying to preserve their business.”