Laura Starks began her presentation at the Inquire Europe Autumn Seminar by noting the decline in traditional mutual fund flows and the simultaneous rise in ETF popularity: “Actively managed domestic equity mutual funds… have just been going down over time,” she said, pointing out that active ETFs are now “picking up a lot of the flows.” The U.S. market, she emphasized, leads this shift due to “greater liquidity, higher volume, and lower transaction costs” as well as a more favorable regulatory and tax environment.
A significant part of Starks’ discussion focused on how regulation has adapted to support innovation in ETF structures. The SEC’s 2019 rule changes paved the way for semi-transparent and non-transparent ETFs, addressing concerns about competitors copying portfolio strategies. As she explained, “The SEC provided rule changes… to allow for semi-transparent and non-transparent ETFs,” creating models such as the “black box” structure (where only authorized participants see full holdings) and the “proxy basket” structure, which publicly shares representative holdings instead of exact ones. Despite these developments, she noted, “The majority today of the active ETFs are fully transparent,” although semi-transparent funds are expected to grow, particularly in Europe.
Starks detailed how mutual fund families can enter the active ETF space through new launches, conversions, cloning, or new share classes. Using real-world examples from Dimensional Fund Advisors, Fidelity, and Vanguard, she illustrated how fund managers balance innovation with competition and regulation. Notably, Vanguard’s share-class model (which allows one portfolio to serve both mutual fund and ETF investors) offers efficiency and tax benefits. “If they want to sell off shares,” she explained, “they can move that into the ETF, and that means that their mutual fund shareholders are not going to have to pay capital gains taxes on those shares.” She also noted that once Vanguard’s patent on this model expired in 2023, “more than 60 mutual fund families petitioned the SEC” to use a similar structure.
The research, co-authored with Linda Du and Mindy Xiaolan, investigates whether cloning a mutual fund into an ETF diverts investor capital from the original fund. Surprisingly, Starks revealed that both cloned mutual funds and their ETFs benefit, stating: “We find no evidence of cannibalization. In fact, it’s the opposite. We find that the mutual fund that is cloned does better, they get more flows than before the ETF was introduced.” Her findings show that cloned ETFs typically come from “older, larger, higher expense ratio” funds with strong reputations, and that these clones attract new flows due to brand credibility. Although this flow advantage fades over time, converted ETFs (where the mutual fund becomes a standalone ETF) retain their momentum longer.
In conclusion, Starks reflected on the broader implications of active ETF growth. The rise of cloned and converted ETFs, she argued, highlights a segmentation in the market between ETFs and mutual funds and between the two types of ETFs. Because the current structure of retirement market platforms impedes the use of ETFs, mutual funds have a legacy advantage on those platforms and the cloned ETF attracts a different retail clientele. Further, ETFs tend to attract retail investors seeking accessibility: “You could invest in an ETF for a dollar,” she noted, contrasting that with mutual funds’ higher entry requirements. The research supports the idea that “the cloned mutual fund appears to have a reputation for better past performance, fund size, and fund family size,” helping both versions thrive. Starks concluded that innovations in ETF structures and fund conversions are reshaping the competitive landscape, creating new opportunities but also new questions about market concentration and efficiency in the evolving world of asset management.