While the number of new actively managed ETFs brought to market has nearly tripled since the Securities and Exchange Commission made significant rule changes in 2019, the limitations brought about by Rule 6c-11 and the business of money management has stopped many managers from issuing ETF versions of their successful mutual funds.
One reason that popular and profitable mutual funds may never see ETF versions is because it simply may not be profitable for the manager to convert them. With fee compression, an equivalent ETF could eat into a manager’s more profitable mutual fund business.
“The ETF market is more competitive than the mutual fund market. Asset managers need to price their ETF versions competitively,” ETF Trends’ head of research Todd Rosenbluth told Barron’s. “There is a legitimate fear of cannibalization.”
Regulatory and investment reasons have also kept managers from issuing ETF versions of their popular mutual funds. The 2019 rule changes allow active managers to run their ETFs in semitransparent portfolios that hide some of their holdings from investors.
But the rules for semitransparent ETFs are more restrictive. The securities in these ETFs trade on public exchanges simultaneously with the funds, which mitigates the chance of pricing irregularities. However, this means that most foreign equities are excluded, since domestically traded ETFs may have difficulty accurately pricing them when overseas exchanges in different time zones are closed. Bonds that trade in private over-the-counter deals are also out. Some illiquid domestic small-caps that don’t trade regularly could also be challenging.
And with the way the current regulatory system is structured, some mutual funds will never work as semitransparent ETFs. The massively popular T. Rowe Price Capital Appreciation Fund (PRWCX) not only owns bonds and preferred stocks, but it’s also closed to new investors, which is something an ETF can’t easily do.
Scott Livingston, head of ETF strategy at T. Rowe Price, told Barron’s that the semitransparent structure can work with small-caps, but “there are other considerations for a large manager like us around capacity.” A fund like the T. Rowe Price Small-Cap Value (PRSVX), for example, is already dealing with capacity constraints.
Livingston also noted that Wall Street has difficulty working with closed ETFs, since the supply of new shares is cut off.
Still, T. Rowe Price offers a suite of actively managed ETFs. T. Rowe Price has been in the investing business for over 80 years through conducting field research firsthand with companies, utilizing risk management, and employing a bevy of experienced portfolio managers carrying an average of 22 years of experience.
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