“If you look at the US, there’s a huge trend of mutual fund into ETF conversions… we’re aware of probably another eight to 10 lined up at least this year,” said Ciarán Fitzpatrick, head of ETF servicing Europe at State Street Bank. “Out of the top 50 asset managers globally, I think the last time we looked, 35 to 36 of them now have ETF ranges while a number of others are acting as an investment manager for ETFs on behalf of another issuer,” Fitzpatrick told Delano.
[The tax advantage] doesn’t exist in Europe and will therefore not likely result in large scale mutual fund to ETF conversions.
Fitzpatrick noted that several active managers were initially reluctant to make the conversion. Many are coming to terms with the harsh reality of the flows. He observed $160bn of inflows into European ETFs whereas there was $30bn of outflow from mutual funds.
He thinks that the capital gain exemption for ETFs is a “massive” incentive for the conversion as “there’s all sorts of strategies in the US to avail of that.” The tax advantage “doesn’t exist in Europe and will therefore not likely result in large scale mutual fund to ETF conversions.”
Transparency requirement: At risk of losing your edge?
Yet he thinks that US and European active managers may set up ETFs on some of their flagship active strategies where “they feel comfortable publishing their holdings daily…. without giving away their IP [intellectual property] on, say, very complex derivative strategies.” He noted these strategies do not have to be published in mutual funds contrary to ETF products.
In line with the US, Canada and Australia, Fitzpatrick noted that there has been “a push to reduce transparency” in Europe but he does not believe that Luxembourg’s Financial Sector Supervisory Commission (CSSF) nor the Central Bank of Ireland are entertaining this option given the low priority of the topic on their agenda.
To provide comfort to fund managers, Fitzpatrick argued that: “the IP isn’t in what you’re publishing… the IP is using your algorithms, your analysis, expertise within the firm you’re going to hold.” He does not think that the regulatory requirement will “give away a huge amount [to competitors].”
Active managers in search of solutions
“It’s very much back to basics [as with passive ETFs 15 years ago], because we’re with those managers [who] have never read a lot of about them or never considered ETFs at all… The asset managers are like: how do I get into this [active ETF] space? What do I need to do? What are the costs associated with it?” said Fitzpatrick.
Not anything new, but Fitzpatrick expects asset managers to seed an ETF range to size quite quickly by using capital from their existing mutual funds given the challenge of getting external capital on the back of high interest rates.
Wanna issue an ETF? Build, buy or rent
Fitzpatrick thinks that building a structure from scratch “comes with a timescale of kind of nine to 12 months.” This is a typical avenue with large asset managers. Another alternative is to use or “rent” a white label platform from firms such as Goldman Sachs ETF accelerator, Waystone or HANetf.
For a fee, Fitzpatrick explained that these companies will let fund managers use their Sicav and Icav platforms and act as a third-party management company, use them for listing registration, distribution, do the investment management and the capital market operations. The products may be offered in Luxembourg, but he noted “the trend more recently has been towards Ireland.”
Fitzpatrick noted that HANeft has been the first and the most successful to date and is serving the whole spectrum of fund managers: small, medium and large asset managers. He commented that the HANetf platform is beneficial for firms looking to launch two, three or five ETFs out of its Ucits umbrella.
As for Goldman Sachs or Waystone, Fitzpatrick explained that these firms will launch a Sicav or an Icav designed for the fund manager’s needs or use their white label structure whereby the ETF is launched from an existing Icav or Sicav.
The third option for traditional mutual fund managers is to acquire an independent ETF issuer. Fitzpatrick noted that Cathy Wood’s ARK from the US, the technology asset manager, recently bought Rize ETF in Europe. Its Ucits platform and technology enables ARK’s flagship strategies “to start launching straightaway” under the ARK brand.
Easier implementation for managers already in Luxembourg
Fitzpatrick explained that the interpretation of European Securities and Markets Authority guidelines by the CSSF enables fund managers to replicate a strategy coming out of a mutual fund or a Sicav into an ETF share class (e.g., to be named Ucits ETF class) that will be offered on the stock exchange. He observed that BNP Paribas and Amundi, amongst others, have been active users of the set-up.
Contrary to Ireland, Fitzpatrick explained that a second advantage is that Luxembourg does not have a US double taxation treaty. “So [the managers] don’t have to worry about adding an ETF or a mutual fund share class.”
Liquidity: getting to a reasonable bid-ask spread
“Trying to get to an asset level as a new manager in that space is going to be key,” admitted Fitzpatrick. He said during the interview that the issuers need a capital markets team that may be only one person that is “monitoring Bloomberg and other platforms” to ensure an adequate bid-ask spread.
ETF: a cure for mutual fund outflows?
“ETF isn’t gonna solve a problem with a mutual fund bleeding assets,” stated Fitzpatrick. He explained that the companies setting up ETFs are not all active managers. Some are also . Both generally had successes with their strategies before launching their ETFs.
As a supporting evidence, he noted that Dimensional ETFs experienced “significant growth” after converting successful products (mutual funds). “It’s just wrapping an existing strategy in a different distribution channel in a different and more efficient structure.”
Active ETFs contributing to efficient markets
As for mutual funds, active ETFs may contribute to eliminate valuation gaps between the large market caps and the small caps. More specifically, Fitzpatrick commented that smart beta, for instance, “looks at income, value or potential future growth or momentum. They look at numerous different factors.”
“Everything’s not a broad-based index at the moment anymore.” He gave the example of ESG strategies which are starting with a broad-based index that is then filtered out based on thematics, for instance.
This article was published for the Delano Finance newsletter, the weekly source for financial news in Luxembourg. .