MFDF Insights: ETF Ask Anything
MFDF recently hosted an In Focus titled Ask Anything – ETF Edition. Paulita Pike and Jessica Reece, partners at Rope & Gray, Brett Eichenberger, Market Leader, Registered Funds at Cohen & Co. and Ward Bortz, ETF Portfolio Manager and Head of Distribution for U.S. Wealth at Angel Oak Capital, joined MFDF to share their expertise.
The following represent some of the questions discussed by independent directors and the expert presenters.
Q: How should directors think about fee comparisons between funds and ETFs with similar strategies?
A: Directors should note that different wrappers require different levels of operational complexity. For any product to be launched successfully, it must be competitive within the space in which it is going to be launched. As long as one product is not subsidizing another, it is the adviser’s prerogative to determine that it will have a different profit margin on one product compared to another. Platforms generally expect fee differentials to be within 20%. Boards will want to build a record that questions have been asked and answered that support their understanding of the rationale for fee differentials.
Q: What are the tax considerations of ETFs that directors should be aware of?
A: The primary tax benefit of ETFs is that the Internal Revenue Code permits ETFs to use in-kind transactions with APs without recognizing capital gains, because individual shareholders are not involved. Certain investments such as some international investments, bonds or swaps cannot be executed with in-kind transactions and so there may be a limited amount of capital gains distributions.
Q: Should directors expect to see an increase in private credit investments in ETFs?
A: Not necessarily. Recent SEC co-investment relief that allows investment by closed-end funds alongside investments by the adviser is not available to open-end funds, including ETFs. In addition, APs may not be willing to accept private credit investments for in-kind transactions, which would mean that these transactions would have to settle in cash and thereby increase the fund’s capital gains distributions. A key question for boards to managers of ETFs seeking to add private credit exposure would be why an ETF would be the appropriate vehicle for this type of investment.