Mutual Funds Converting to ETFs Offer Tax Benefits for Investors
A growing number of mutual funds are converting to exchange-traded funds (ETFs), a trend that experts say is positive for investors. Since the beginning of 2021, there have been over 70 mutual fund to ETF conversions, with nearly three dozen occurring in 2023 alone, according to Morningstar Direct. And experts anticipate that more conversions are on the horizon.
Daniel Sotiroff, senior manager research analyst for Morningstar Research Services, stated, “It’s steadily increasing year-over-year,” highlighting the shift in investment trends.
One of the driving factors behind this surge in conversions is a 2019 change from the Securities and Exchange Commission that provided fund managers with more flexibility. This change has facilitated the transition from mutual funds to ETFs, according to Sotiroff. The conversion itself is tax-free for the investor and switches from actively managed mutual funds to ETFs, which offer greater tax efficiency.
“That’s a big selling point,” Sotiroff emphasized, noting that year-end mutual fund capital gains distributions can be a burden for investors with actively managed mutual funds in brokerage accounts. Additionally, many fund managers realized gains in 2023 to meet investor redemptions, resulting in double-digit projected payouts for some funds. In contrast, most ETFs do not distribute capital gains at the end of the year, making them more attractive to investors in terms of taxes.
Despite the recent increase in mutual fund to ETF conversions, CFP Matt Knoll, senior financial planner at The Planning Center in Moline, Illinois, noted that it is still relatively rare to see. Sotiroff also added that the conversions have been relatively smaller actively managed mutual funds worth around $100 million or less, with the exceptions of larger, well-known conversions like Dimensional Funds and JPMorgan.
Looking ahead, Sotiroff anticipates that future conversions are likely to be smaller, actively managed mutual funds outside of 401(k) accounts. Overall, the trend towards mutual fund to ETF conversions is providing investors with additional tax benefits and increased flexibility in their investment portfolios.