By Lewis Braham

"If mutual funds didn't exist today, would they have to be invented?" asks manager John Neff of the Akre Focus mutual fund. "I think the answer is very uncomfortably 'no.'"

Neff plans to convert the $11.8 billion mutual fund (ticker: AKREX) into an exchange-traded fund in late October. Tax efficiency "is the biggest reason to do it," he says. By law, mutual funds must pay out taxable capital gains realized when a money manager sells appreciated stock shares. But ETFs allow managers to hand off their appreciated shares to financial intermediaries without distributing capital gains.

Since 2021, 145 mutual funds have converted to ETFs, yet there are trade-offs. Most institutional retirement plans aren't set up to allow ETF trading, so mutual funds that are offered in 401(k) plans can't easily convert. Moreover, although there are certain "semitransparent" ETF structures that allow active managers to conceal their portfolios, investors prefer full transparency. That means showing one's investment cards every day.

"If you look at the folks who've already gone through the conversion process, there's very little interest in the nontransparent active ETFs anymore," says Dave Nadig, ETF.com's director of research.

In Akre's case, the fund is suited for conversion as its client base isn't in 401(k)s and Neff trades infrequently -- the fund has a low 5% turnover ratio -- so there isn't much for outside traders seeking to piggyback on his investments to see daily. He also invests in large and midsize stocks that are easy to trade in a daily-liquidity ETF format.

But the biggest benefit is that the tax cost basis for the fund is $4.6 billion, he says, with the rest of the fund's assets, about $7.2 billion, in unrealized capital gains. The ETF structure will help his shareholders avoid receiving any taxable distributions on those gains. The fund's expense ratio will drop from 1.33% to 0.98%.

Not every conversion makes sense. One of the earliest firms to do so was Dimensional Fund Advisors, which converted two mutual funds, DFA Tax-Managed International Value to the Dimensional International Value ETF (DFIV) and DFA Tax-Managed US Equity to the Dimensional U.S. Equity Market ETF $(DFUS)$ in 2021. DFA "had some mutual funds that were already 'tax managed,'" says Daniel Sotiroff, a senior analyst at Morningstar. "It made sense to convert those because the ETF is just a more tax-efficient vehicle." Tax-managed mutual funds aren't generally offered in tax-advantaged retirement plans.

DFA's funds have been excellent performers and fit well in the ETF space as they are low-fee, have low turnover ratios, and typically hold hundreds of stocks, so liquidity and transparency aren't problems. For similar reasons, Fidelity has succeeded with low-cost quantitative active strategies it has converted, such as the Fidelity Enhanced Large Cap Core ETF $(FELC)$. J.P. Morgan has also fared well with a number of low-cost bond funds investing in large, liquid markets, such as the JPMorgan Mortgage-Backed Securities ETF (JMTG).

Unlike mutual funds, ETFs can't close to new investors -- even if managers invest in illiquid securities and have limited capacity. For this reason, some ETF conversions appear problematic. The Abrdn Focused U.S. Small Cap Active ETF $(AFSC)$, which made its debut in February from its former life as the Abrdn Focused U.S. Small Cap Equity mutual fund, currently invests in only 44 small-cap stocks.

Even if the ETF performs well, a concentrated portfolio is unsuited for the ETF format. It could run up against liquidity constraints and suffer from trading transparency.

"If your strategy requires your ability to move significant portions of the firm's assets into a small-cap or microcap stock over a period of days without signaling [to other investors] you are going to be accumulating that position, then you have no business being an exchange-traded fund," Nadig says.

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September 18, 2025 02:30 ET (06:30 GMT)

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