Understanding the reasons behind mutual fund conversion to ETFs
Recorded on 12th May 2023.
Ron O'Hanley: Dave, it's good to see you today, and thanks for doing this, and let's jump right into this. I always thought of Dimensional as really disregarding ETFs, yet Dimensional made a big move in its decision to convert mutual funds to ETFs. So, can you talk a little bit about that, Dave?
Dave Butler: Thanks for having me, Ron. This is a great pleasure to be here. And, just to start off on the ETF front, so we converted seven ETFs, or seven funds, tax-managed mutual funds into ETFs, and then we've launched 23 other ETFs. So a total of 30. The conversion was about $40bn. Overall, we're now about $85bn in ETFs. And your question is a great one. The question for us really was: would we be able to add value in the ETF space like we have in the mutual funds space for the last 40-plus years? And the answer to that really came in September of 2019 with the ETF rule. So, if you look at our mutual fund business and, as I said, 40 years into it – we have our microcap fund, which is a 41-year fund now, it has a 41-year track record… that's beating the Russell 2000, it's benchmarked by about 160 basis points for 41 years – so really significant outperformance, and that's really what the business was built around. It was trying to add value above and beyond just a standard index type of an approach. So that's what we did in the mutual fund space for many, many years. We wanted to be able to do that also in the ETF space. And when the September 2019 ETF rule came around, which allowed us to do customised baskets, allowed us to have flexibility in trading, allowed us to do daily implementation, allowed us to have this precise exposure to the higher returning areas of the market. That was sort of when we launched into action.
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text: Advisor focus: Transitioning from mutual funds to ETFs
Ron O'Hanley: One of the hallmarks of Dimensional is that you've provided tools and training systems for your advisers. What's been the take-up with advisers? Have you lost advisers along the way, have you gained advisers?
Dave Butler: It's been terrific. I mean, we were unsure at the very start as to what the reaction would be but, frankly, the reaction was very, very positive. We had a client base that was tax-aware. We had advisers that were working with us on that conversion, so that was terrific. And then we've just worked with advisers on the ETF question, and how that ETF solution fits into their business. And what we've seen over the last five to ten years is ETFs have become a bigger and bigger part of many adviser businesses. We spent a lot of time educating and training advisers on what we do and how we differentiate ourselves from others in the market, including just straight index funds. And that educational training process has been really helpful for us in terms of getting great traction early on, and then also making sure that advisers understand exactly what we're doing in the process. So, some people have asked about the fact that we've just come into the ETF business, but the way I look at it really is we've been working with advisers for 30-plus years now, and these advisers are very familiar with our approach. And we've built up a lot of trust with those advisers through the years by setting expectations and meeting those expectations on a regular basis. And this idea of us going into ETFs was a very fluid decision. I think it was a fluid aspect of our business, transforming and developing alongside the adviser businesses that's developed and gotten more specialised over the years.
Ron O'Hanley: Is that the way you think about it, Dave, that this is an evolution in your relationship with the advisers and the ultimate investor? You've evolved the vehicle from the mutual fund to the ETF, but what you're trying to do is really the same thing, trying to create better outcomes for the ultimate investor here.
Dave Butler: Yeah, I think so. We have a great, what we call a “feedback loop” with the advisers and, really, what we've always been in the business of doing is trying to deliver a great client experience. And we think there's two parts to that. One is the capital market expertise – that's what I think Dimensional brings to the equation, and then there's the client expertise, and that's what the independent adviser brings to the equation. So you put those two together and you have a great chance at a great client experience. And our view is, we wanted to be, and we need to be and we continue to innovate ways that we can be part of that equation. It’s been a great elevation of our business, and it’s been a great elevation of the relationship with the adviser and their delivery to the client.
Ron O'Hanley: I think that is distinctive about what you've done, because you've had this very distinctive approach about how you've taken your investment products, really trained up and partnered with the adviser, and now you've been able to do that with this ETF vehicle.
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text: Active ETFs
Ron O'Hanley: So, active ETFs really went nowhere for a long time: 17 per cent of flows last year, 25 per cent year-to-date flows. What do you expect going forward for active ETFs?
Dave Butler: You know, in our view, I think it lines up a lot with the transition over time from more active, classic active management activities in the mutual fund space, and indexed mutual funds taking a bit of a lead there. When I started the business back in ‘95, the number that was quoted was around 4 per cent of assets were indexed, and now people say it's 40, 50, 60 per cent. So I see that same thing, the same kind of phenomenon, the same evolution, if you will, in the ETF space. You know, again, ETFs are great from a diversification perspective, from a cost perspective, tax-efficiency perspective. I think where we, on the systematic active side, can add value is through this, again, daily implementation and more precise, better exposures to the higher expected returns of the areas of the market. So, the main point being that I think the active ETF, systematic active ETF, has a lot of room to grow. I think there's an interest level and excitement level that we're just starting to see, and that's probably reflective of the first quarter numbers you just mentioned, and I think we're going to see more of that, going forward.
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Text: The next big thing in ETFs
Ron O'Hanley: So, as you know, part of the purpose of interviewing you is that it's 30 years since the first ETF was launched and, on the one hand, that seems like a long time. In reality, it's not, really. What do you think is the next big thing in ETFs, as you look forward?
Dave Butler: I do think, again, the systematic active ETF is the next big lever up from where we are here. I think it's an important story, and it's a differentiated story that people are just starting to recognise that you can access that excess return. You can implement, in a way, a daily implementation that's going to add value to your portfolio over time in this ETF wrapper. So, I think that's the big one, and I think that's one we're hyper-focused on as we talk to advisers, particularly in institutions, as well. We're hearing and seeing more of those types of engagements and conversations around that topic, and the differentiation there from a trading perspective, a daily implementation perspective, is really shown to have added value on the mutual fund side. It's starting to show it in the ETF side, and I think that'll be a big wave, going forward.
Ron O'Hanley: You've shown that you can bring active returns with real precision at a reasonable cost to portfolios, so congratulations.
Dave Butler: Thank you. We've been having fun with it. A lot of credit to the team here. We worked really hard for two years from our first launch in November 2020 to today. And, like I said, we've seen a lot of great movement towards this approach in the ETF space. We think there's a value add, as you point out, that could be captured and one that will be captured, going forward, and we're excited to be able to deliver that to the clients, both institutions and advisers.
Ron O'Hanley: Great, Dave. Dave, thanks for doing this. it's a real honour to be able to talk to you today.
Dave Butler: Honoured to be here as well, Ron. Thank you, and I appreciate the time.
Ron O’Hanley, State Street’s Chairman and CEO discusses the rise of mutual fund conversions to ETFs with Dave Butler, co-CEO of Dimensional Fund Advisors. In the three-plus years since the SEC adopted the “ETF Rule,” Dimensional has become the largest active ETF issuer.
Founded in 1981, Dimensional has a long history of applying cutting-edge financial research to practical investing. They have applied this expertise as the first company to convert mutual funds to ETFs at scale.
As the ETF market continues to evolve, Butler predicts that active ETFs are the next step in delivering value on the mutual funds side, offering investors a differentiated opportunity to access higher returns at a reasonable cost.
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Today, among the nearly 12,0001 ETFs in existence, SPY is the largest2, most liquid3 and most heavily traded4 ETF in the world. Our ETF@30 video series examines the past, present and future of ETFs ꟷ and their impact on the world’s financial markets and industries.
1 ETFGI Global ETF & ETP Insights May 2023 report
2 Bloomberg Finance L.P., as of December 12, 2022
3 Bloomberg Finance L.P., as of December 12, 2022
4 Bloomberg Finance L.P., as of December 12, 2022
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