In short, the requirements to launch and run an exchange-traded fund were made more uniform. So, it allows for quicker, simpler and cheaper launches, consistent reporting on issuer websites and some other technical changes mostly impacting issuers. But the direct impact to the shareholder is what prompted our team at Aptus Capital Advisors to alter our business as the rule became law.
New Tax Benefits
Passive ETFs that track an index have always had the ability to avoid capital gains distributions purely from the structure of the ETF wrapper. Quality active strategies couldn’t access the same benefit — until Rule 6c-11.
Why own a mutual fund that faces annual distributions as high as 10-30%, when I can own an ETF that does the same thing and will not distribute capital gains? Answer: There is no reason to.
The opportunities inside this rule are massive, so let’s unpack them one constituent at a time.
The rule shortens timeline and lowers cost to launch for ETF issuers, which should increase the number of entrants. Instead of being shackled to an index agent, a rules-based manager can be flexible and offer the ETF tax benefit to its shareholders. If you can attract enough investors, you can maintain flexibility and ultimately benefit from operational leverage.
Rule 6c-11 is a huge win all around for ETF owners. The structural inefficiency of the mutual fund wrapper can be shed in favor of a tax-advantaged ETF wrapper. Even a high-turnover strategy can now shield its owners from capital gains distributions.
As an advisor, you face the risk of “too much choice”, but your universe of tax-efficient vehicles is expanding. Your clients can now control when they want to pay taxes, instead of having distributions thrust upon them by the timing of the mutual fund manager.
The Future of Portfolio Construction
Mutual funds were already facing a number of headwinds and the ETF rule is accelerating their extinction. A skilled manager who wanted the tax benefit, but also the flexibility on day-to-day operations, can now get both by running an ETF. An allocator tasked with managing a portfolio of funds may now see the benefit of having those changes made under the ETF hood while shielding clients from gains.
The Future of Asset Management
We shifted our entire business as the rule became law in September 2019 and think other managers will do the same. We continue to operate rules-based funds, but now make changes at our discretion, not the black-and-white rules of a back-tested index.
Fund shareholders get the best of our thinking and tax-efficiency and advisors can make their satellite positions as tax-friendly as their core positions. It’s rare to see a win-win-win, but as far as we’re concerned, the SEC pulled it off with Rule 6c-11.
JD Gardner (left), CFA, CMT, is founder and managing member of Aptus Capital Advisors. Derek Hernquist is director of advisor experience at Aptus Capital Advisors.