Morgan Stanley's investment management arm announced on Wednesday its decision to convert eight municipal bond mutual funds into exchange-traded funds, transitioning nearly $10 billion in assets under management as of August 31. According to reports from ETMarkets, the firm plans to launch seven newly created ETFs to house the bulk of these assets, while the remaining mutual fund will be merged into an existing ETF. As reported by Bloomberg Intelligence ETF analyst Eric Balchunas, this represents a rare filing for Morgan Stanley and notes the new ETFs should perform well, particularly if the fee lands at the institutional share class level or below. The conversion involves Eaton Vance state municipal bond funds, which are currently available only as closed-end funds or mutual funds, offering holders intraday exchange trading and likely cheaper fees. Holders of Eaton Vance state muni mutual funds and closed-end funds would gain intraday liquidity and lose the persistent discounts to net asset value that closed-end funds carry.
The conversion comes as municipal bond mutual funds have experienced heavy outflows due to anticipated Federal Reserve interest rate increases this year. As reported by ETMarkets, bond prices typically drop when hotter-than-expected inflation or robust economic data suggest the central bank may raise rates or delay cuts. Retail investors often react sharply to this volatility, withdrawing cash from mutual funds during periods of rising rates or market uncertainty. According to Bloomberg Intelligence, municipal bond funds carry tax-exempt income that already attracts yield-focused investors, and an ETF wrapper adds the tax efficiency of the ETF structure on top, broadening the appeal beyond their existing shareholder base. Recent market data shows investors pulled about $1.8 billion out of the municipal bond market this week, with returns for state and local government debt on track to tumble for the third consecutive month. September's volatility has pushed year-to-date muni returns down roughly 1.7%, as reported by Bloomberg.
According to ETMarkets, the eight municipal mutual funds slated for conversion hold four- or five-star ratings from Morningstar and have track records of more than 15 years. Morgan Stanley's conversions act as a defensive measure to retain client assets by adopting the ETF wrapper. The company aims to prevent cost-conscious investors from shifting their capital to rival exchange-traded funds that offer similar strategies. Ally Wallace, global head of ETFs at Morgan Stanley investment management, stated that the appetite for actively managed municipal ETFs is growing and believes the conversions will offer transparency and greater accessibility for investors. As noted by Bloomberg Intelligence, the fee tier determines whether everyday investors get the cost structure large institutions currently enjoy, with the conversion removing structural disadvantages like persistent discounts to net asset value that closed-end funds carry.
This latest conversion builds on Morgan Stanley's successful track record in converting fixed income mutual funds to ETFs. As reported by ETMarkets, the firm previously converted five fixed income mutual funds to ETFs, which have significantly increased their assets since conversion and continue to maintain their 4-or 5-star Morningstar ratings. Notably, Eaton Vance Total Return Bond ETF and Eaton Vance Short Duration Municipal Income ETF converted in March 2024, and as of August 31, EVTR has grown from $363 million to over $6 billion and EVSM has more than tripled its assets. If the conversion proposals are approved by shareholders, seven of the municipal mutual funds will be reorganized into newly created, actively managed ETFs and one municipal mutual fund will be reorganized into the existing Eaton Vance Short Duration Municipal Income ETF. The latest conversion demonstrates Morgan Stanley's continued commitment to expanding its ETF offerings while maintaining the high-quality standards of its existing municipal bond products.
Since launching in 2023, Morgan Stanley investment management's suite of ETFs and products has grown to encompass 22 offerings with more than $16 billion in assets under management. As reported by ETMarkets, the firm believes the potential conversions will allow their municipal investment team to offer ETF solutions that span the entire municipal yield curve and credit spectrum in a structure that offers transparency and greater accessibility for investors. The underlying municipal bond market remains unaffected by these structural changes, with the focus being on asset retention and product evolution. Following the proposed ETF conversions, MSIM's ETF platform will include a wide spectrum of municipal offerings across duration and income profiles, with the firm's proven track record in successful conversions providing confidence in the strategic value of these initiatives.
