Rowe, rowe, rowe your boat, gently toward fixed income.

T. Rowe Price will acquire F/m Investments, a fixed income asset manager and exchange-traded fund specialist with about $19 billion under management, according to an announcement on Thursday. The move will expand T. Rowe’s fixed income offerings and is expected to close next year. It’s the second ETF manager acquisition this month, following Goldman Sachs’ announcement that it planned to acquire NEOS Investments, after closing on its acquisition of Innovator Capital Management in April.

“Overall, [T. Rowe Price is] a massive investment manager, but they’re really heavily weighted on the equities,” said Neil Bathon, a managing partner at FUSE Research Network. The deal “bolsters a fixed income business that needs probably more balance in order to be seen and actually being able to deliver those customized solutions.”

A Rising Tide

F/m was the first firm to offer single-security ETFs, as well as the first to file an application for tokenized ETF shares and to launch mutual fund shares of ETFs. T. Rowe’s distribution capabilities will allow F/m’s funds to scale at a level that they wouldn’t have been able to otherwise, said Alexander Morris, co-founder of F/m. “They always tell you the first billion is the hardest, then it’s the second, the third. Well, turns out it’s still true at the 19th and the 20th,” said Morris. “We didn’t want to just keep growing at a few billion a year. It’s how do we 10x this?”

Here’s the deal by the numbers:

• It’s expected to increase T. Rowe’s fixed income AUM by about 9%.
• However, the deal will more than double the firm’s fixed income ETF assets under management, as well as expand its fixed income SMA business.

Wave It Off: Despite Goldman’s recent acquisitions, the deal doesn’t signal a larger wave of consolidations, according to both Bathon and Morris. “Consolidation is a story advanced by M&A groups,” said Bathon. “There are as many firms today as there were 20 years ago … This [deal] is opportunistic and strategic, and I don’t know that I think it plays into a broader consolidation theme.”

It’s always good to go with the flows … inflows, that is.

Passive investing may be pulling down the active market, a new research paper found, which argues a decline in active fund performance since 2010 has been driven by allocations to passive funds. As investors pour into index products, specifically passive index ETFs, active managers have to sell down their existing positions, and passive inflows go into benchmark weightings regardless of price, according to the study. It can also be a self-reinforcing cycle for active funds, which tend to have higher fees, said Brendan McCann, a senior associate manager research analyst for Morningstar.

“If an active fund performs poorly, and investors run for the hills to get out of the active fund, now that active fund has fewer assets, so you can lose economies of scale,” McCann said. “That makes it harder to compete on cost, which can be almost like a self-fulfilling prophecy.”

Performance Anxiety

The reason passive inflows affect active performance is that stocks held by active funds experience selling pressure while underweighted stocks benefit, according to the paper. Policy may also have something to do with it, said Michael Green, founder of Tier1 Alpha Asset Management. Two decades ago, the Pension Protection Act of 2006 created qualified default investment alternatives, or QDIAs, which became the default investment portfolio in employer-sponsored retirement plans, like 401(k)s. The legislation changed the system from an opt-in framework, where investors had to decide whether to participate and what to buy, to an opt-out framework in which investments are pre-selected. “Because most people don’t want to spend a lot of time thinking about investing, particularly early in their careers, [most] QDIA portfolios never change their allocations,” Green said. “That’s just a natural, behavioral outcome.”

Other key findings from the report include:

• Active fund underperformance has roughly doubled after 2010, with average net alpha for active funds falling from -0.72% annually between 1984 and 2009 to -1.82% annually between 2010 and 2024.
• The sharpest alpha declines were among “high active share funds,” or portfolios whose stock holdings significantly differ from their benchmark index.

Following the Money: One out of every two dollars invested in ETFs went into low-cost, passive funds in the first half of this year. That trend could lead to a homogenized investing environment as active managers realize they won’t make money launching new active strategies anymore, Green said.

“Practitioners who pursue that [active] approach are going to see their returns further degenerated, which in turn causes more people to abandon the principles of actually actively valuing securities,” he added. “We are hollowing out the industry, even as assets under management approach all-time highs.”

That’s one classy move.

Since the Securities and Exchange Commission began giving fund companies the green light via exemptions late last year to add ETF share classes of their mutual funds (and vice versa), few have hit the accelerator. The first to do so, Dimensional Fund Advisors, is already shifting gears. The firm is preparing to move a batch of eight standalone exchange-traded funds to ETF share classes of corresponding mutual funds. And another company, Allspring, last week filed with the SEC to add ETF share classes to five existing funds, a first for it.

“We have standalone ETFs, but there are some benefits associated with merging those into the mutual funds,” said Marlena Lee, Dimensional’s global head of investment solutions, noting that the change will result in fees dropping by 9% on a weighted average basis. “The biggest benefit to our investors is the economy of scale.”

The Tortoise and the Share

As a whole, the industry has moved slowly in rolling out dual share classes. While dozens of firms have exemptions, only a few, including Dimensional, F/m Investments, Thornburg, Fidelity and Nuveen, have actually added share classes of existing products. Vanguard, of course, long had a patent on the ETF share class and has one for many of its passively managed funds. Much of the reason for the slow adoption is the different settlement processes of ETFs and mutual funds; more than a few asset managers specialize in one type of fund, but not necessarily both. Along with that, the industry has had to figure out how distributors used to getting compensated from fees baked into mutual funds can instead get paid by ETFs.

Some of the recent developments in dual share classes:

• Dimensional will soon merge eight ETFs into share classes, including US Core Equity, Vector Equity, Small Cap Value, High Profitability, Real Estate, Small Cap and Targeted Value ETFs.
• That firm also filed in July for five ETF share classes of fixed income strategies.
• Allspring last week filed for ETF classes for its High Yield Municipal Bond, Large Cap Core, Premier Large Company Growth, Short-Term High Income and Strategic Municipal Bond funds.

Class Action: “Investors shouldn’t have to choose between the investment strategy they want and the vehicle they prefer,” said Rick Genoni, who leads Allspring’s ETF business. The dual-share-class structure “is one strategy with more ways to invest. There are a lot of benefits that come with it. Obviously, not the least of which is the tax efficiency.”