More firms likely to roll mutual funds into active ETFs

Huntington Asset Advisors Inc. may be the first fund company to convert an existing mutual fund into an actively managed exchange-traded fund, but it won’t be the last, some observers predict.

On June 17, Huntington Asset Advisors, the investment arm of Huntington Bancshares Inc., filed with the Securities and Exchange Commission to launch two actively managed ETFs. They are the Huntington Ecological Strategy Fund, which will follow environmental themes, and the Huntington Rotating Strategy Fund, an ETF version of its Huntington Rotating Markets Fund (HRIAX), which seeks to shift holdings among various equity market segments where the firm sees opportunities, said Randy Bateman, Huntington’s president and chief investment officer.

Once the rotating-markets ETF is up and running Huntington plans to fold in the nine-year-old mutual fund that follows the same strategy, he said.

“We think the ETF market offers some advantages over mutual funds, and we want to participate in it,” Mr. Bateman said.

In the first five months of this year, ETFs drew net inflows of $22.7 billion and now have $788 billion in assets, according to Strategic Insight. By comparison, mutual funds saw net inflows of $161 billion in the first five months of the year and now have $7.1 trillion in assets.

Huntington joins a number of fund companies that have filed with the SEC to launch actively managed ETFs. In the past few weeks, BlackRock Inc. and Dreyfus have also filed to launch such ETFs.

There are a total of 23 actively managed ETFs with a total of $2.2 billion in assets, according to Morningstar Inc.

For the most part, fund companies are filing to launch actively managed ETFs as placeholders so that they can be ready if these products take off in popularity, observers said.

“They just want to have the op-portunity available to launch these offerings, but they aren’t rushing to get to market with them,” said Paul Justice, an analyst at Morningstar.

Their reluctance to launch actively managed ETFs stems from the fact that unlike mutual funds, ETFs offer real-time trading information and thus could put firms at a competitive disadvantage — particularly if they have active ETFs that replicate their mutual funds.

By folding its mutual fund into the new ETF, Huntington hopes to sidestep that issue altogether. Others will likely follow, experts said.

“I think this is going to be the first of many,” Tom Lydon, a registered investment adviser and president of Global Trends Investments, said about the ETF.

“ECONOMICALLY FAVORABLE’

Fund companies realize that they have to get into the ETF market to grow but that there are already too many index-based ETFs, he said. As a result, these firms are going to turn to active strategies, and that will likely mean converting some of their mutual fund portfolios into ETFs.

“I think there will be more companies that do this because it’s going to be more economically favorable for advisers and their clients,” Mr. Lydon said

The Huntington Rotating Markets Fund is a fund of funds, which makes it easier to disclose real-time trades without giving away too many trade secrets, said Tom Graves, equity analyst at Standard & Poor’s.

“In these kinds of diversified funds, a decision to buy or sell a stock isn’t going to be viewed as a significant type of disclosure,” he said. “I would gather that the more diversified funds are going to be the most likely candidates for this kind of transition.”

Another benefit that Huntington will derive by folding its mutual fund into its new ETF is that the ETF will likely be able to use the fund’s three-year track record. “Most actively managed ETF strategies have a tough three-year road ahead of them,” Mr. Justice said. “This could give them a big boost.”

That is one of the reasons that Huntington wants to fold the fund into its ETF, Mr. Bateman said.

The $39.8 million Huntington Rotating Markets Fund posted a 9.5% loss for the three-year period ended last Monday, slightly underperforming the 8.4% loss for the average fund in its category, according to Morningstar. The fund has a three-star rating from Morningstar.

Huntington executives are re-viewing how the firm could use the fund’s track record with the new ETF. The manager of the mutual fund, Paul Koscik, will manage the ETF.

If Huntington can reference its mutual fund track record, it will prompt other fund companies to follow in its footsteps, said Dave Nadig, director of research at IndexUniverse.com.

SOLVING A PROBLEM

“If they are able to inherit the track record, that will solve a big problem that the active ETF managers have faced,” he said.

Having a track record will definitely get the fund on more financial advisers’ radar screens, but that doesn’t mean that they will invest in it, said William E. Koehler, chief investment officer at ETF Portfolio Partners Inc.

“This is a sign of the times, and I think it will be the first of many firms to do this,” he said. “The fact that there is a track record is important, but I still want to see some seasoning because the ETF structure is very different than a mutual fund.”

Merging the existing mutual fund assets into the new ETF should also help get market makers’ attention, Mr. Bateman said.

“We are the newbies, and there are some players who have been in the ETF business a very long time,” he said. “You need a certain level of assets just to get the support of the major market makers.”

Huntington is already discussing which other of its mutual funds may do well in an ETF format.

“We are going to see how this goes, but there is nothing that would necessarily prohibit us from doing this with some of our other funds if it makes sense,” Mr. Bateman said.

For example, eventually the firm may convert its Dividend Capture Fund (HDCAX) into an active ETF because it could provide a higher yield outside the mutual fund format, he said.

“Mutual fund requirements re-quire that all expenses be paid first from income, then if there isn’t enough income, from the principal,” Mr. Bateman said. “That inhibits how much yield can be passed on through the mutual fund structure.”

Huntington doesn’t have a time-table for when it will make a decision regarding whether to convert the Dividend Capture Fund into an ETF.

E-mail Jessica Toonkel Marquez at [email protected].

“MOST ACTIVELY MANAGED ETF strategies have a tough three-year road ahead of them.”

Paul Justice

Analyst

Morningstar