In a notable shift within the investment landscape, KKM Financial has transitioned its Essential 40 mutual fund into an Exchange-Traded Fund (ETF). This transformation is emblematic of a larger trend among asset managers who are increasingly favoring ETFs over traditional mutual funds. The primary driving force behind this migration is the desire for greater tax efficiency—an aspect that has become increasingly important for investors and their advisors. While mutual funds can result in unexpected tax liabilities due to capital gains distributions prompted by investor redemptions or changes in the fund’s portfolio, ETFs offer a more flexible approach to managing tax implications, allowing investors to control the timing of their capital gains or losses.
Jeff Kilburg, the founder and CEO of KKM Financial and a contributor to CNBC, elucidates the significant tax advantages that ETFs hold over mutual funds. He highlights the concerns many wealth advisors have regarding the capital gains distributions typical in mutual funds, which can undermine an investor’s returns. The increasing demand for tax-efficient investment vehicles reflects a broader shift in investor preferences, as they seek ways to optimize their portfolios while minimizing tax burdens.
The conversion of traditional mutual funds into ETFs is not merely a trend but is significantly influenced by the regulatory environment. A pivotal change occurred in 2019, when the Securities and Exchange Commission (SEC) introduced a rule that facilitated active investment strategies within ETFs. This pivotal alteration has resulted in a notable decline in the number of active equity mutual funds, reaching a historical low not seen in over two decades. According to data from Strategas, asset managers are responding to this changing landscape by adapting their products to align with modern investment strategies that are more conducive to the dynamic market conditions.
Furthermore, there is ongoing advocacy from many asset managers for the SEC to permit ETFs to exist as separate share classes within existing mutual funds, further enhancing the versatility and attractiveness of ETFs. KKM’s Essential 40 fund, now trading on Nasdaq under the ticker symbol ESN, exemplifies this innovative approach. This fund is designed to enable investors to “buy what you use” through an equal-weighted structure, fostering diversification and potentially reducing risk.
The Essential 40 ETF includes a curated selection of pivotal companies that are vital to the U.S. economy. With notable holdings like JPMorgan Chase, Amazon, Waste Management, and Eli Lilly, the ETF aims to represent sectors that are viewed as essential for economic stability and growth. Kilburg articulates the rationale behind the fund’s strategy, suggesting that without these influential companies, the broader economy could face significant challenges.
The performance of the prior mutual fund version of the Essential 40 adds credibility to its new incarnation as an ETF. Holding a three-star rating from Morningstar, the fund demonstrated resilience during market turbulence. In 2022, it recorded a decline of less than 11%, outperforming the category average, which dipped around 17%. This resilience can be attributed in part to its equal-weighted methodology, which has historically shown better performance during market downturns compared to market-cap weighted indices.
The ETF market has been witnessing a surge in interest, particularly for equal-weighted strategies. An illustrative example is the Invesco S&P 500 Equal Weight ETF (RSP), which has attracted over $14 billion in new funds in 2023, underscoring investor demand for diversified investment strategies during times of uncertainty.
As of early 2024, the KKM Essential 40 ETF registered an impressive year-to-date gain of approximately 16%, bolstered by around $70 million in assets prior to its transformation. The ETF maintains a net expense ratio of 0.70%, consistent with its former mutual fund counterpart, ensuring that investors do not face additional fees associated with this strategic transition.
KKM Financial’s conversion of the Essential 40 mutual fund into an ETF not only reflects an individual asset manager’s response to evolving market dynamics but also highlights a broader shift towards more tax-efficient and flexible investment strategies. As investor preferences continue to evolve, the adaptability of ETFs will likely play a crucial role in shaping the future of investment management.