The rapidly expanding exchange-traded fund (ETF) industry is increasingly encroaching on the territory of separately managed accounts (SMAs), a development that follows its significant impact on the mutual fund sector. Since 2021, mutual funds in the U.S. have experienced over $1 trillion in outflows, while ETFs have attracted $2 trillion, as reported by Morningstar. ETFs have also gained traction in Europe and Asia, albeit more slowly, prompting numerous mutual fund-to-ETF conversions as asset managers shift towards this rising investment structure.
Now, the ETF industry is setting its sights on SMAs, a previously fast-growing segment within the $120 trillion global asset management industry. London-based white-label ETF issuer HANetf recently completed what it claims to be the first SMA-to-ETF conversion in Europe, building on a burgeoning trend in the U.S. Tidal Financial Group and Goldman Sachs have also undertaken similar conversions on their ETF platforms.
This trend caught significant attention earlier this year when Eagle Capital Management completed a conversion worth more than $1 billion through Goldman Sachs, highlighting the growing interest in SMA-to-ETF transitions. Despite the rapid growth of SMAs, which saw U.S. assets jump from $952 billion in 2017 to $2.2 trillion by the end of last year, some managers and investors are now considering ETFs as a viable alternative.
The initial conversion by HANetf involved an SMA managed by Lloyd Capital, a Swiss wealth manager, for a Mexican family office, resulting in the launch of two ETFs: the Lloyd Focused Equity Ucits ETF (FEP) and the Lloyd Growth Equity Ucits ETF (GEP). The conversion offered several advantages, including tax benefits and the ability to create a centralized offering, attracting smaller clients and external funds.
In the U.S., the tax advantages of ETFs are a primary driver for conversions, as ETFs can often avoid annual capital gains taxes that SMAs must pay, with investors typically only being taxed when they sell their ETF holdings. This tax efficiency is a significant attraction for investors, as noted by Mike Venuto, co-founder and chief investment officer of Tidal Financial Group.
However, the shift from SMA to ETF is not without its challenges. SMAs with highly customized strategies may struggle to appeal to a broader audience as an ETF, and the conversion process would require adherence to diversification rules, which could limit investment flexibility. Additionally, the exclusivity of being an SMA client might be lost in the transition to a widely accessible ETF.
While the pace of SMA-to-ETF conversions is expected to be gradual, with only a few anticipated in the U.S. this year, the trend is gaining momentum. Europe is also likely to see more conversions as the ETF model continues to resonate with investors and asset managers across the globe.
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