This story appears in the December 19, 2016 issue of Forbes. Subscribe
Since earning his M.B.A. from Columbia in 1967, Mario Gabelli has surfed some of the biggest waves in finance. He started as an analyst at Loeb, Rhoades when brokerage commissions were still fixed and Wall Street profits easy. After commissions were deregulated in 1975, he formed an independent research firm and then his own hedge fund before jumping into mutual funds in the 1980s.
Now the 74-year-old billionaire value investor is ready to ride what he sees as the next big wave: exchange-traded managed funds (ETMFs). He's gotten SEC approval to offer five ETMFs, including equity-income, small/midcap and media funds.
It's a big deal for a famous stock picker like Gabelli to get into ETFs. Since the 1993 debut of SPDR, the first S&P 500 index fund traded on a stock exchange, ETFs have been synonymous with indexing. A paltry $27 billion of $2.4 trillion in ETF money is actively managed, compared with $11.1 trillion of $16.4 trillion in traditional mutual funds. That's because ETFs must disclose their holdings every night, whereas traditional mutual funds have to show their hand only quarterly, with a 60-day lag. Active managers shun daily disclosure, fearing other investors will copy their stock picks.
Yet for taxable investment accounts, ETFs' advantages are compelling, particularly when an active manager has a big score. After Berkshire Hathaway completed its $37 billion acquisition of Precision Castparts this year for $235 a share, "my clients who got into the stock at $8 were stuck paying taxes," Gabelli complains.
All mutual funds are required to pass on their taxable gains to investors annually, but ETFs and ETMFs minimize that hit through how they create and redeem shares--rather than sell fund shares directly to the public, they trade with broker dealers and institutions and move individual stocks, not ETF shares, in and out. An ETMF could have swapped out its Precision Castparts stock before the merger was complete, allowing individual investors to defer recognizing taxable gains until they sold their ETMF shares, just as real estate investors defer gains with property exchanges.
What about daily disclosure? Gabelli is avoiding that by licensing a patented ETMF structure from Eaton Vance called NextShares, which won SEC approval after four years of scrutiny. Like regular ETFs, NextShares trade on an exchange during the day and you buy them from other investors or market makers, not the mutual fund company. But they settle based on their net asset value at day's end, calculated without disclosure of holdings to investors. Eaton Vance launched the first NextShares fund in February and has licensed the structure to a dozen other firms so far.
Gabelli predicts that over time active managers will move en masse to ETMFs--assuming Uncle Sam doesn't either close the stock-swap tax loophole or extend deferral of gains to traditional mutual funds, too. "I've been around for 50 years and see the tax disadvantage of conventional mutual funds," he says. "But it could be changed."
