Wall Street Expects Fee Bonanza As $1 Trillion In Mutual Funds Become ETFs

This week, a quiet milestone in the changing nature of the asset-management industry passed without much notice from the heavily preoccupied financial press – and no, we’re not talking about Invesco’s latest volley in the buy-side fee wars.

On Monday, Dimensional Fund Advisors converted $29 billion in mutual funds into ETFs via Citigroup, one of Wall Street’s biggest transfer agents, which served as the intermediary for the transaction. Now, executives in Citi’s ETF business are babbling to Bloomberg about how the slow decline of the mutual fund industry (in favor of faster, cheaper ETFs) is about to kick into hyperdrive.

2020 was a very good year for ETFs but not for mutual funds. ETFs had net inflows of $502 billion, led by taxable-bond ETFs, which collected nearly half those assets, while mutual funds saw outflows of $289 billion, according to Morningstar data. This dynamic has been on display for years at this point, as the growing popularity of ETFs and passive-investing strategies in general draws more assets from mutual funds, which are typically more costly than ETFs due to various tax-related inefficiencies.

While it’s not exactly clear when (some once thought it would have happened by now), but at some point, many believe that ETFs will eventually dwarf mutual funds in terms of assets.

According to the latest MorningStar data, long-term mutual funds and ETFs saw inflows of $83 billion during May, with $71 billion of that going to index-tracking ETFs.

The entire US ETF market is worth nearly $5 trillion, while mutual funds still have more than $18 trillion in assets, with another $4.5 trillion in money market funds.

Source: Morning Star

Now, if Citi’s self-serving estimate is to be believed, more than $1 trillion in mutual fund assets might migrate to the ETF space, especially as more funds file to change over from mutual funds to actively traded ETFs, a business that generates generous profits for the trading desks of banks and market makers. While $1 trillion is definitely a significant sum, it’s still only 10% of mutual fund assets.

As transfer agent, the Wall Street bank made sure investors holding the four mutual funds from the quant giant on Friday were able to see and trade their shares in the exchange-traded funds this week.

Now the bank expects the record conversion to be the first of many.

“We have clients and non-clients alike reaching out to us asking us about this,” Peggy Vena, Citigroup’s director of ETF product development for North America, said in an interview. “I think we’re going to see more and more of this.”

In the coming decade, more than $1 trillion worth of mutual fund assets could be converted into ETFs, according to an analysis by Bloomberg Intelligence. The first switch took place in March, opening the door for a host of mutual funds that have spent years watching assets shift to generally cheaper, easier-to-trade ETFs.

Also, for the many smaller mutual fund firms out there, making the switch now could help them get in early, helping them gain market share in lucrative markets, and potentially making them acquisition targets for bigger rivals.

Most of the resistance to the shift from mutual funds to ETFs comes from the world of pensions, which is still heavily geared toward mutual funds. But there are also tax advantages to the ETF wrapper that many firms find enticing.

Dimensional instantly became one of the biggest players in the $6.5 trillion U.S. ETF arena this week with its switch. The Austin, Texas-based firm with $637 billion under management has already filed for at least two more conversions.

Switching is complex and likely wouldn’t suit all mutual funds — the U.S. pension system is geared heavily toward the more established product, for example. But there is a strong appeal for money managers, not least the relative tax advantages of ETFs.

But the biggest winners of all will be the transfer agents, like Citigroup, BBH and others, who can expect more trading volume, and therefore, more fees, as investors increasingly favor “passive” ETFs.