More from the ConvergEx note Wednesday:
This all sounds pretty benign and maybe a little too technical to really be interesting, but make no mistake: this is potentially a huge development for a whole range of Wall Street players. A few concluding points, with some highlights about why this merits your attention:
- The Securities and Exchange Commission still has to approve this structure. Navigate is doing the heavy lifting here, and they just filed an ‘Amended Exemptive Application’ on September 12th. No telling how long it will take to get SEC approval, but the wheels are in motion.
- Once the structure receives approval, the existing U.S. mutual fund complex has billions of dollars which can move fairly quickly. Given the headline “50 basis point” cost advantage, a typical fiduciary – bank trust department, broker, financial adviser – will have to at least take a look at swapping some of their mutual fund shares for the equivalent ETF.
- There are still a host of Wall Street players which have business models based on the existing order. Brokers rely on 12b-1 fees (those ongoing payments) for their income. Institutional brokers sell their research for commissions controlled by their mutual fund manager customers. Transfer agency services still make money for mutual fund complexes. The ETMF structure dislocates most of these payment streams. No 12b-1 fees, a create/redeem process rather than manager-controlled trading, and no transfer agency.
As I left the meeting this afternoon, some of these concerns were making their way to the floor during the Q&A period. That is textbook Innovator’s Dilemma, with many existing constituents troubled by what these changes mean for their businesses. All that will have to get worked out, to be sure, for this idea to fly.
Still, the whole arc of this discussion – ETFs, mutual funds, and the differences between the two – is important for bigger reasons than just whether a broker gets his commission check. Active management is important to a well-functioning capital market. How that happens – mutual funds or active ETFs – matters very little in the end. If mutual funds do not work out a way to respond to ETFs now, it will only get harder as time goes by.