Fee compression, evolving tax priorities, and demand for liquidity are reshaping how asset managers deliver strategies to investors. For many SMA sponsors, the question is no longer whether to scale beyond bespoke accounts, but how to do so efficiently while preserving client tax advantages.
A Section 351 conversion offers a path forward.
This IRS-recognized transaction allows managers to contribute SMA assets into a newly formed ETF in a tax-deferred exchange. The result is a structure that can deliver the same core strategy in a wrapper designed for scale, distribution reach, and operational efficiency.
Converting SMA holdings into an ETF through Section 351 can deliver value opportunities on multiple levels.
Maximize After-Tax Growth Potential
By deferring capital gains taxes until ETF shares are sold, more capital remains invested and compounding over time. This can materially improve long-term after-tax returns while preserving original cost basis and holding periods. For high-net-worth and institutional investors, aligning tax deferral with portfolio growth objectives offers a powerful planning advantage without triggering a taxable liquidity event.
A Section 351 conversion can also be used to contribute appreciated securities into an ETF at launch, enabling portfolio adjustments without realizing immediate taxable gains. This approach is particularly valuable for investors with concentrated positions, as it allows them to diversify into broader market exposure while retaining the embedded tax deferral. In practice, these conversions often help maintain a fund’s strategy while providing the flexibility to realign holdings over time, which can be especially attractive in managing legacy portfolios or shifting market exposures.
This tax efficiency is only one piece of the equation; however, operational scale is equally important for managers looking to compete in today’s market.
Streamline and Scale Portfolio Management
Combining multiple SMA accounts into a single ETF centralizes oversight, replacing fragmented processes with a unified structure. Intraday liquidity, daily holdings transparency, and simplified reporting reduce administrative burden, allowing advisors to devote more resources to client engagement and strategy. Operational scalability can be a competitive advantage for managers seeking to grow assets without proportionally increasing costs. With streamlined operations, managers also gain new flexibility in the types of strategies they can deliver to a wider audience.
Expand Strategic Flexibility and Market Presence
The ETF wrapper enables strategies that may be difficult to implement across individual SMAs, from targeted factor tilts to thematic allocations. In practical terms, this structure can accelerate time-to-market for innovative approaches, providing first-mover advantages in specialized exposures. Exchange distribution, market-maker relationships, and established liquidity channels can raise visibility and secondary-market activity, supporting brand recognition and investor confidence. Notably, certain active nontransparent formats limit daily holdings disclosure, which may influence liquidity characteristics. While these benefits are compelling, achieving them requires careful attention to the regulatory and operational steps that underpin a successful conversion.
Key Requirements and Execution Risks
To qualify for intended tax treatment, contributed assets should satisfy diversification requirements consistent with the 25/50 test: no single position over 25 percent of assets, and positions above 5 percent cannot exceed 50 percent in aggregate. In addition, the contributing parties, as a group, must own at least 80 percent of voting power and total shares immediately after the exchange. Maintaining detailed lot-level cost-basis and holding-period records is critical, as these will determine tax results when ETF shares are sold.
Aligning contributed assets with the ETF’s stated objective from inception reduces the likelihood of early rebalancing and associated tracking error, which can affect investor perception and trading behavior. Liquidity planning is also essential. Establishing relationships with authorized participants and market makers before launch helps support competitive spreads and active secondary-market trading, factors increasingly viewed as indicators of product viability. For managers who want to navigate this process with confidence, an experienced partner can help integrate all these elements into a cohesive launch strategy.
Why Partner with Tidal for Your 351 Conversion
Navigating a 351 conversion requires coordinated tax, operational, and market experience. Tidal offers a full-stack ETF platform, guiding clients from initial feasibility through post-launch growth. Services include portfolio structuring to meet IRS and regulatory standards, execution of regulatory filings, operational setup, and launch logistics. Post-launch, Tidal provides fund administration, compliance oversight, capital markets support, and go-to-market strategy services.
If you are considering a Section 351 conversion, we can help you evaluate the right level of control for your goals and guide you through every step to launch an ETF positioned for long-term success.
For additional perspective, see the recent Bloomberg coverage featuring Brittany Christensen, SVP of Business Development at Tidal Financial Group, on Section 351 conversions.
