Investment Company Notebook

Practical insight and analysis on the accounting, audit and tax issues impacting investment companies.

Introducing BBD's Industry Insights Video Series

Welcome to Industry Insights, BBD’s new video series that offers our clients and industry friends a brief look into important and timely developments in the investment management industry.

In our first episode in the series, BBD's Jim Kaiser had the great pleasure of speaking with Jace Schuppan of The Nottingham Company about mutual fund to ETF conversions. The Nottingham Company worked with one of the very first funds to convert from a mutual fund to an ETF. The discussion explored:

  • The benefits of converting a mutual fund to an ETF
  • Why conversion may not be a fit for every fund
  • Challenges such as shareholder approval and conversion of direct shareResized LinkedIn for HubSpot 294 x 168holders
  • Key takeaways from the process


Jim Kaiser 0:00 Welcome to Industry insights, BBD's video series that offers our clients and industry friends a brief look into important and timely developments in the investment company industry. I'm Jim Kaiser, BBD's managing partner. And today I have the pleasure of speaking with Jace Schuppan, Executive Vice President of Business Development at The Nottingham Company. Jace and I will be speaking about mutual fund to ETF conversions. The Nottingham Company has recently worked on one of the very first to convert from a mutual fund to an ETF. So Jace, can you can you start off maybe by providing a brief overview of The Nottingham Company and the services that your firm offers to investment management clients, including mutual funds and ETFs?

Jace Schuppan 0:40 Yeah, thank you very much Jim. I appreciate being here. So Nottingham is one of the largest independently owned fund administration and accounting firms in the United States. And we partner with asset managers and registered investment advisors to create and service pooled investment solutions, so registered and non-registered investment solutions. And that includes ETFs, mutual funds, hedge funds, foundations, endowments, and more. We were founded in 1988, and currently service over $33 billion in assets. And our services include fund organization, fund accounting, fund administration, transfer agent services and compliance. So from turnkey series trust and white label ETF solutions to fully customized service solutions, we offer flexible, cost-effective services tailored to the needs of each client.

Jim Kaiser 1:24 Great, thanks. I guess getting on to the topic at hand, can you give us a brief overview of some of the key benefits of converting a mutual fund to an ETF?

Jace Schuppan 1:34 Sure. The tax efficiency, liquidity, ease of trading, the transparency, the lower cost, those are all well-known benefits. And those factors really have created the kind of key benefit for fund managers, which is broad investor demand. Converting a mutual fund to an ETF really allows advisors to tap into that swelling demand and widen their distribution opportunities. So ultimately, it comes down to what investment vehicle financial advisors and investments and investors excuse me prefer. And clearly demand is for ETFs. You know, I think if you talk to any of these first few firms that have converted, you find the decision really came down to that investor demand and distribution opportunity.

Jim Kaiser 2:14 Great. So, I'm assuming that and maybe this is not a correct assumption, so correct me if I'm wrong, but I'm assuming that a conversion from a mutual fund to an ETF may not be a fit for every mutual fund. What are some of the reasons why a mutual fund may want to think twice about converting to an ETF?

Jace Schuppan 2:31 Yeah, you know, if the mutual fund has significant retirement plan assets, an ETF may not be the best solution at this stage. As you know, retirement plan assets are tax-advantaged accounts. And they have long investment horizons typically. So the tax efficiency and intraday trading that's offered by ETFs are not as critical. And additionally, the traditional recordkeeping systems for retirement plans are not set up to handle ETS. So technology upgrades, which may be costly, are required to accommodate broad reception of ETFs within the retirement plan space. So I think that's probably your biggest factor. There may be some factors with, you know, fund strategies and things that make sense. And depending on what, you know, they're going after whether it's, you know, transparent, non-transparent, some of those factors may play into that as well.

Jim Kaiser 3:16 Sure, there's some limitations on some of those models as far as types of securities and whatnot. Yeah, I'm also hearing that, you know, one of the one of the challenges in converting a mutual fund to an ETF is potentially having to obtain shareholder approval to do the conversion. Can you touch on why some funds may need to obtain shareholder approval? Why others may not need to obtain the approval?

Jace Schuppan 3:39 Yeah, you know, each conversion really can be unique, right, which is why the evaluation and expertise of your partners is really important. I believe the conversions that have been completed so far have relied on that N-14 Information Statement, and they did not need to obtain shareholder approval. But I do want to caveat, you know, I'm not an attorney. So I would really defer to legal counsel for that judgment.

Jim Kaiser 4:01 Fair enough. You know, for years, whenever this topic would come up, you know, converting a mutual fund to an ETF, the hurdle that many would point to is, you know, how do you convert direct shareholders of the mutual fund, into ETF shares, you know, you have to have a brokerage account to hold ETF shares. Can you explain how you were able to overcome this challenge?

Jace Schuppan 4:24 Yeah, you know, certainly the coordination of communication and notification to shareholders is critical. So direct shareholders were asked to provide brokerage account information prior to conversion. And if that information was not received, the transfer agent was able to hold those shares until instruction was received from those shareholders.

Jim Kaiser 4:44 So there are some significant operational differences between a mutual fund and an ETF. How does The Nottingham Company help Trustees gain comfort with some of those differences and some of the uniqueness of an ETF so they can provide their oversight responsibilities?

Jace Schuppan 5:00 Sure, you know, it really it's through education. We focus on explaining those operational differences, such as how shareholders transact by buying and selling on an exchange through a broker-dealer. There's no direct transfers, or excuse me direct transfer agent subscriptions, the create/redeem process and the authorized participant's role in creating/redeeming shares. And then the portfolio security trading with cash versus in-kind, and how trades, you know, within the ETF portfolio are typically done in-kind as non-taxable transactions. Additionally, our strategic partners like BBD are critical in helping to educate the Trustees with presentations detailing operational differences and the processes they follow to address those structural differences. Great. So now that you've been through one conversion, what's your biggest takeaway from it, you know, specifically the one you recently completed? You know, the industry wide flow data really tells the ETF demand story. And we're seeing firsthand kind of the validation of that post-conversion. The ETF is seeing strong flows and trading volume along with increased investor interest. So it's kind of great to see that macro narrative playing out in this recent conversion. I think that's the biggest takeaway.

Jim Kaiser 6:13 So if a fund group is interested in converting, what would your recommended course of action be?

Jace Schuppan 6:20 Reach out. Let's start the dialogue to see if you know, this endeavor makes sense for your fund and firm. It's a complex process; it requires a lot of planning and coordination and guidance. So having experienced and consultative partners is going to be crucial.

Jim Kaiser 6:33 How do you think this, you know, the whole mutual fund to ETF conversion, you know, how do you think that's going to impact the industry going forward?

Jace Schuppan 6:42 You know, I really believe this is going to be a monumental transformation for the industry. You know, we're just at the start of the mutual fund to ETF conversion story that's going to play out over the years to come. And I don't want to sound like a you know, that's not to sound like a broken record, but demand drives actions. And clearly investors are demanding ETFs. Now that the first few have blazed this conversion path, I think we're going to continue to see a growing level of conversion activity. Not ironically, the coverage and mentions and discussions have picked up since DFA completed the recent conversion of several mutual funds. So I think it's you know, as you see more big players going in, it's clear that this is the future.

Jim Kaiser 7:21 I happen to agree with you. You know, Jace, I'll close out with one final kind of catch-all question. Is there anything else you think we should know about converting a mutual fund to an ETF?

Jace Schuppan 7:32 Yeah, the process is going to be unique for each fund and firm. So I would really just reiterate kind of the importance of working with experienced and consultative partners. You know, ultimately, I believe that ETFs present the best asset-raising opportunity going forward for investment managers. And because of that, I think conversion should be at least on the list of strategic initiatives to explore for every mutual fund firm. You know, there certainly are still some industry adaptations to come. But investor demand is definitely clear. And I think this is the path we're going down.

Jim Kaiser 8:01 Right. Well Jace, thanks so much for your time today. We really appreciate your insights. And I think this was great and helpful. So thank you!

Jace Schuppan 8:09 Jim, I really appreciate it. Thanks for having us. And thanks for being a great partner.