This article appears in the September 2022 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.
By now, the differences between ETFs and mutual funds are well known. But what’s less understood are the differences between standalone ETFs and ETFs structured as a series of a mutual fund.
“ETF series investors and mutual-fund series investors in the same pool of assets can have very different performance outcomes,” said Prerna Mathews, vice-president, ETF product and strategy, with Toronto-based Mackenzie Investments.
This pooling works to the disadvantage of the ETF series, said Mathews, who summarized her observations in a paper that outlined the benefits and drawbacks of each structure.
“It is more about the education and knowing what you’re buying, not necessarily saying one is always superior,” Mathews said. To improve disclosure, she advocates naming conventions that clarify when an ETF is part of a series rather than a standalone.
Since assets held by the various series of a mutual fund trust are commingled, so are the operating expenses associated with units being bought and sold. The ETF series units bear their share of these costs, which the fund manager typically deducts monthly.
However, only the ETF series unitholders bear the cost associated with buying and selling units on a stock exchange. In addition to any brokerage commissions, this cost comes in the form of the spread between the bid and ask prices.
“There’s a cost to transacting, and the rest of the unitholders don’t need to bear the cost of you moving in or out of the ETF,” said Mathews. As a result, the total return of a series F mutual fund will probably be higher than that of the corresponding ETF series, even if both series charge the same management fee.
“It’s not really fair” to ETF investors, Mathews added, since the ETF series still is affected by purchases and redemptions in all the other series.
But with a standalone ETF, there’s no commingling of creation and redemption costs. The investor remains in control of when such costs occur, which are baked into the bid/ask spread.
The impact of that spread on an ETF series varies. The spread could be as little as a penny or much more for a volatile fund that is riskier for market makers to price.
“They have to factor in being able to provide you with intraday liquidity,” Mathews said.
At last count, a dozen fund manufacturers have created ETF series of their mutual funds, including large companies such as BMO Asset Management Inc., CIBC Asset Management Inc.and PIMCO Canada Corp. Independent firms have created ETF series as well, including Evolve Funds Group Inc., Picton Mahoney Asset Management, Purpose Investments Inc. and Starlight Investments Capital LP. (All these firms are based in Toronto.)
Mackenzie hasn’t joined those firms. “That is not to say that we may never launch them,” Mathews said. “But I would say there has to be strong rationale where the benefits far outweigh the drawbacks.”
Another drawback of an ETF series is that the ETFs held must disclose their holdings continuously to market makers. That may not sit well with portfolio managers who worry about potential front-running.
There can be cost advantages to creating ETF series of mutual funds, particularly when the pool of fund assets isn’t large. Adding an ETF series can be cheaper than creating an ETF that requires regulatory filings and legal and accounting fees.
“There are benefits to pooling assets together, and the scale that can achieve,” Mathews said, “and what that can do in terms of performance outcome potentially for clients.”
When there’s a choice between placing a client in a mutual fund series rather than the ETF series of the same fund, Mathews said, financial advisors should address several questions: How meaningful is the ETF exposure versus just buying series F? Does the client truly need intraday liquidity? Will you be using intraday liquidity to tactically move positions in the client’s portfolio? Or are you simply looking to add more ETF exposure and an ETF series is a convenient way to do that?