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Wednesday, January 25, 2023

Is the Death of Mutual Funds Greatly Exaggerated?

Reported by Sean Hanna, Editor in Chief

The days of traditional open-end mutual funds may be numbered. That is the conjecture of the "Godfather of ETFs," Reggie Browne. And he is not just talking his book. Browne, principal at GTS, contends that the SEC's "swing pricing" rule could be the nail that seals the coffin-lid on traditional '40 Act funds. If Browne is right, you may be calling mutual funds "trad-funds."

Reginald Matthew "Reggie" Browne
Browne says that swing pricing would be hugely expensive to interact with and deploy inside of a mutual fund but that capability is "really what an ETF does."

"They [the SEC] are talking about that every mutual fund must have a swing price which means that those who are exiting gets one price while those who are buying into it get another price," Browne says. "Very expensive to deploy. In my opinion a lot of the '40 Act, open end mutual funds will convert into ETF format because of those regulatory pressures."

He adds that best interest regs are also driving financial advisors to ETFs and away from traditional funds.

"For financial advisors delivering advice to their clients, having exchange traded mark-to-market instrument, it is easier to move clients into ETFs than into other products that have regulatory pressures from a best interest perspective," Browne says.

Meanwhile, the difficulty of converting traditional funds shares to ETFs is coming down as more custodians have gone through the process. In the past, that conversion has been painful for advisors who must reach out to clients with paperwork as part of the conversion.

Traditional fund sponsors have also resisted converting to ETFs because they lose their direct connection to shareholders and the chance to build on existing relationships.

Yet, a third development that could pull traditional funds to convert to ETFs is Vanguard's upcoming loss of its patent over the use of ETFs as "just another share class" in a hub-and-spoke fund. When that patent goes away, fund sponsors will be able to add an ETF share class without the headaches of moving existing shareholders out of their traditional shares.

"I expect that as soon as the first large asset manager offers a multi-share class structure every asset manager will offer a multi-share class," predicts Doug Yones, head of exchange traded products at the NYSE.

"I comfortably predict that you will see exemptive relief filings this year for asset managers that want to use a multi-share class process for their ETFs," Yones explains. "The multi-share class process can be remarkable for asset managers because it provides all of the provisions about a direct conversion into an ETF while removing some of the hurdles and some of the steps without having to move all of your transfer agency shareholders to a brokerage platform. I think that the next few years will be quite large for multi-share class."

The ETF format may especially appeal to fixed income managers. That format simplifies the retail purchase of bonds, putting it on a similar footing to equity investing. Yet one area where the ETF format will remained challenged is in 401(k) plans. Recordkeepers in that market are not willing to adapt platforms to allow real-time trading of ETFs, and plan sponsors and advisors still rely on revenue sharing structures that are not carried within the ETF structure.

The 401(k) market is also one that is fighting the SEC's proposed swing pricing rules tooth and nail. Industry leaders worry that the rules would force 401(k) plans to trade at next day prices rather than same day prices. If Browne is right, the rules could also mean that 401(k) plans are trapped in an eddy while the rest of the industry moves downstream. 

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