American Funds to get approval to offer ETFs

Massive mutual fund operation could come storming into a popular investment product

Feb 4, 2015 @ 10:43 am

By Trevor Hunnicutt

In a move that could pave the way to a new order in the fund industry, securities regulators plan to approve a proposal by American Funds, the third-largest mutual fund brand, to offer ETFs for the first time.

The decision, announced this week by the Securities and Exchange Commission, clears the way for the manager of $1.2 trillion in mostly broker-sold mutual funds to build its own exchange-traded funds, a product that has most of its assets flowing into products that replicate an index. American Funds is the largest mutual fund manager without a lineup of ETFs.

It remains unclear if American Funds will bring ETFs to market. After the commission staff’s decision was announced late Monday, Tom Joyce, a spokesman for American Funds parent, Capital Group Cos., said the company is “leaving our options open at this point.”

“We continue to have interest in the concept of active ETFs,” Mr. Joyce said. “But, this approval aside, we have no immediate plans to offer ETFs of any kind. This allows us to consider, to explore and to have conversations with the industry participants.”

Still, the company’s active interest — including two proposals filed since July — indicate the seriousness with which mutual fund managers are treating ETFs, once a backwater but now the fastest-growing asset management product, in part because of the growing number of advisers who rely more on fees charged directly to clients than on commission revenues paid by fund houses.

American Funds sells only through financial advisers and brokers, but that’s an increasingly tough business, and the company has had seven straight years of redemptions totaling $261 billion, according to an estimate by Morningstar Inc. Most of those outflows have come in “load” funds, which are sold by financial advisers and brokers who collect commissions from the sale. ETFs provide no such remuneration to the adviser.

“American Funds has gone through a very, very difficult period and have come through it reasonably well,” said one top industry consultant who declined to be named. “They realize they really have to be a full-time participant in the industry. They can’t be above the fray.”

Perhaps ironically, Los Angeles-based Capital Group is partly responsible for the popularity of index-based investing. A Capital subsidiary in the 1960s invented MSCI indexes tracking international markets. While MSCI Inc. is now independent, it retains the “C” in its name, which once stood for “Capital.” In the U.S., an estimated $269 billion in ETF assets track MSCI indexes, according to Morningstar.

Before last year, American Funds maintained that it had little interest in the ETF market, in large part because of holdings transparency.

The filing by American Funds that the SEC is poised to approve would require it to disclose its holdings daily, which has been an insurmountable ask for many managers. It would allow the firm to file for ETFs investing in foreign and domestic stocks and bonds. In its filing, American Funds said its first fund would likely “seek to provide long-term growth of capital, with income as a secondary objective.”

Though the SEC intends to green-light the application, opponents of the proposal can still submit a request for a hearing before the commission. Based on past experience, such a hearing is unlikely.

The agency has relaxed its view on active management in ETFs in recent years. Active funds account for just 1% of the ETF market.

In 2012, regulators reversed a 2-year-old moratorium on derivatives use in the funds, a benefit to existing active ETF managers, including Pacific Investment Management Co.

In December, the SEC approved a request to let a new type of security trade that combines facets of mutual funds and ETFs, marketed as “NextShares” by Eaton Vance Corp. Those funds don’t require immediate portfolio holdings disclosure.

Around the same time, the agency denied and publicly rebuked a version of a proposal backed by fund managers, including Capital Group, for nontransparent actively managed ETFs. The SEC said the mechanics of that proposal could destabilize capital markets. The proposal’s sponsor, Precidian Investments, has refiled with regulators.

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