According to CNBC, asset managers are increasingly launching mutual fund strategies as exchange-traded funds, with 56 mutual funds converting to ETFs in 2024 alone—a dramatic increase from just 15 conversions in 2021. Another 40 funds have converted so far this year, reflecting a steady acceleration of this trend as managers seek to capitalize on ETF popularity. The movement includes both direct conversions of existing mutual funds and the creation of ETF “clones” that offer identical strategies in ETF format. Experts note that ETFs generally provide better tax efficiency and lower costs for retail investors, particularly those with taxable brokerage accounts. This structural shift represents a fundamental change in how investment products are packaged and sold to consumers.
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The Hidden Costs of Conversion
While the cost advantages of ETFs are well-documented, what often goes unmentioned is the operational complexity behind these conversions. When a mutual fund converts to an ETF, the underlying portfolio must be restructured to accommodate the creation/redemption mechanism that makes ETFs tax-efficient. This process can trigger hidden tax consequences for remaining mutual fund shareholders, as the fund may need to sell securities to align with the ETF structure. Additionally, the due diligence burden shifts to investors, who must now understand bid-ask spreads, premium/discount dynamics, and trading liquidity—concepts that were irrelevant in the mutual fund world where shares were priced once daily at net asset value.
The Liquidity Illusion
One of the most promoted benefits of ETFs is their intraday tradability, but this feature creates a double-edged sword that many investors underestimate. Unlike mutual funds, where everyone receives the same end-of-day NAV, ETF investors face execution risk throughout the trading day. During periods of market stress, ETFs can trade at significant discounts to their underlying NAV, particularly for funds holding less liquid assets. The SEC has repeatedly warned about this disconnect between ETF liquidity and the liquidity of their underlying holdings. For investors accustomed to the predictability of mutual fund pricing, this introduces a new dimension of risk that requires careful monitoring.
Strategic Implications for Long-Term Investors
The conversion trend raises important questions about investment strategy consistency. When a fund converts from mutual fund to ETF structure, managers may subtly alter their investment approach to accommodate the different liquidity requirements and shareholder base of ETFs. The constant visibility of ETF holdings—required for the creation/redemption process—can also impact a manager’s ability to build positions quietly. According to investment research, this transparency, while beneficial for some investors, can undermine the very strategies that made certain mutual funds successful in the first place, particularly in less efficient markets where information advantage matters.
The Regulatory Gray Area
As this conversion wave accelerates, regulatory oversight remains fragmented. The SEC’s proposed reforms for fund naming conventions and disclosure requirements haven’t fully addressed the unique challenges of converted funds. Investors may not realize that a converted ETF operates under different regulatory frameworks than one built from scratch as an ETF. The historical performance data presented often blends the mutual fund and ETF periods, creating potentially misleading comparisons. This regulatory gap means investors must perform their own deep due diligence rather than relying on the simplified “ETF = better” narrative being promoted across the industry.
What’s Next for the Conversion Trend
Looking ahead, the conversion wave will likely accelerate as asset managers chase lower operational costs and marketing appeal. However, we may see a bifurcation emerge: straightforward equity strategies will thrive in ETF format, while complex, less liquid strategies may struggle with the structural constraints. The real test will come during the next major market downturn, when the mechanics of ETF creations and redemptions face stress testing. Investors should approach converted ETFs with the same skepticism they’d apply to any structural change in their investments—recognizing that while the wrapper may be new and improved, the contents inside still require careful evaluation.
