If you follow the ETF business, you'll know that the "ETF as a share class" patent that mutual fund and ETF issuer Vanguard received in 2001 expires here on Tuesday. Given the flexibility ETF issuers have these days, plus the increasing amount of expertise that exists regarding mutual fund to ETF conversions, I'm not sure this patent is as valuable now as it has been over the years. That said, there have been filings from existing mutual fund issuers regarding adding ETF share classes to existing mutual funds.
While it may not seem significant to some for an issuer to change its product offering, there are a number of operational differences. As you'll see as we look at a mutual fund to ETF conversion that went live on Monday, doing a conversion also can have a big impact on a company's bottom line.
The funds I'm referring to are two emerging market mutual fund strategies that were offered in the US by giant Korean asset manager Mirae Asset Global Investments. Mirae in 2018 acquired US ETF issuer GlobalX and it seems like its plans for the company are taking shape. I wrote earlier about how Mirae took some index calculation business in-house and now it looks like it is starting to get comfortable with the US ETF marketplace with the conversion of these two funds.
The funds are the GlobalX Emerging Markets ETF (EMM) and the GlobalX Emerging Markets Great Consumer ETF (EMC) . While emerging markets (EM) exposure long has been touted as a good diversifier, pundits increasingly have been making the case for markets outside of the US and even Europe for that matter. GlobalX is among them, making the case with this "Insight" article. Some may see the call for increased EM exposure as a tactical/cyclical allocation move and that may be the case, but there is a more strategic/secular rationale behind the GlobalX EM consumer play. This is outlined clearly and succinctly in the piece on the GlobalX website.
The short version is that EM countries traditionally have been economies that tend to produce wealth for a small cohort of citizens. This has been changing over time and we have begun to see the emergence of a bona fide middle class in many of these countries, including China and India. You know, only 2.8 billion people... I'm not saying it's a given that these markets will outperform, but it's not a stretch to think this growing cohort has the potential to create significant demand for goods and services.
The two original mutual funds were launched in 2010 and the conversion to ETFs sees them bringing those years of returns as well as their current assets of just over $22 million (EMM) and $373 million (EMC). This is where the income statement impact I mentioned earlier comes into play.
Both funds are sporting a 75-basis-point expense ratio, so based on current assets under management (AUM) will bring in just about $3 million in fees to the firm. To be clear, a portion of these fees will go to the service providers of the funds. The old mutual fund websites have been decommissioned, but I was able to review the latest annual report for the funds and found the lowest fee shares class had a net expense ratio of 115 basis points and the most expensive share class shows a 215-basis-point fee. Those fees do not include any sales charges, which range from 1% to 5.75% depending on the share class. There is a breakout of the distribution of assets across share classes in the report. I calculated a 120-basis-point blended expense ratio to get to $4.8 million in collected fees based on current assets. This calculation assumes this asset level is maintained for a calendar year.
As you can see from my back-of-the-envelope calculations, making the straight switch from mutual funds to ETFs can be material to an issuer's income statement. As for the funds themselves, EMM faces a truly uphill battle against the $24.5 billion iShares MSCI Emerging Markets ETF (EEM) , but EMC covers a segment that is a little more nuanced and seems to have a better chance of succeeding, at least from an asset-gathering perspective. As you can tell, between the two funds I would lean toward EMC, especially as a mid- to long-term investment, but as usual, I will leave the final analysis to the reader.
