From left: Kevin Grogan, chief investment officer of systematic strategies at Focus Partners Wealth, and Matthew Garrott, director of investment research at Fairway Wealth Management.
Asset managers from BlackRock to Schwab are lining up for exemptive relief, but data suggest initial challenges keeping RIAs and broker‑dealers on the sidelines.
The SEC is opening the path for dual‑share‑class ETFs to roll out – but the wealth management industry is in no hurry to follow.
Several weeks after granting Dimensional Fund Advisors approval to offer ETF share classes on 13 US equity mutual funds, the regulator has now signaled its intent to issue similar orders for 30 more asset managers, including BlackRock, JPMorgan, PIMCO, State Street, and Schwab.
While the SEC’s notice last week has practically opened the floodgates dual‑share‑class structures, industry research and interviews by InvestmentNews suggest advisor demand and especially broker‑dealer readiness will take more time to catch up.
Green lights shine for dual‑share relief
The SEC’s December 17 notice lays out a cross‑section of the asset management establishment preparing to marry mutual funds and ETFs under one umbrella. Among the firms and funds in line:
- BlackRock, across a range of flagship equity and fixed income funds
- JPMorgan, including its J.P. Morgan Exchange‑Traded Fund Trust and multiple mutual fund complexes
- PIMCO, with applications spanning PIMCO Funds, PIMCO Equity Series, and PIMCO ETF Trust
- Charles Schwab’s fund family, including Schwab Investments and Schwab Strategic Trust
- State Street’s SPDR complex, including SPDR Series Trust and SPDR Index Shares Funds
Also on the list are Nuveen, Lord Abbett, John Hancock, Harbor, Morgan Stanley, Thornburg, and Victory, underlining that dual‑share‑class ETFs are being treated as a strategic option across both active and passive houses.
Following the announced approval of DFA’s application last month, Dimensional co-CEO and co-CIO Gerard O’Reilly painted the ETF share class structure as “a significant enhancement in how millions of Americans can access financial markets in the future.
Advisors cool to ETF share classes – for now
If asset managers are eager, advisors are more cautious.
Recent data from Fuse Research show that more than half of advisors (51%) say they prefer standalone ETFs over ETF share classes, while 37% have no strong preference and only 13% favor ETF share classes of existing mutual funds.
At the same time, the vast majority say they would welcome a one‑time, tax‑free exchange from mutual funds into ETF share classes – 83% for qualified accounts and 80% for nonqualified accounts.
“Overall, they didn’t indicate that a great percentage of them wanted that structure in place,” said Mike Evans, partner and director of Advisor and BenchMark Research at Fuse Research, whose firm surveyed more than 500 advisors on product usage and ETF share classes.
Evans sees two key drivers of the ETF‑only bias. First, apart from Vanguard-affiliated advisors, many advisors have little practical exposure to ETF share classes, so their views are largely theoretical.
“There is not an absolute understanding of the nuances and differences between the two,” he said.
Second, he said the beneficial ability to execute a one‑time, tax‑free move from a mutual fund into a more tax‑efficient ETF isn’t yet front‑of‑mind for many advisors.
On top of advisors’ currently limited demand for ETF share classes, Fuse says broader adoption is likely to evolve gradually as distributors and operational systems have yet to mature.
Speed bumps for broker‑dealers
Earlier research from Cerulli Associates this year also pointed to a significant gap between asset‑manager enthusiasm and intermediary readiness.
Cerulli found that while asset managers view dual‑share‑class relief as “the best of both worlds” – preserving mutual fund track records while offering ETF‑style tax efficiency and distribution – broker‑dealers and wirehouses see a thicket of issues including questions, most significantly around Reg BI questions and revenue disruption
On Reg BI, home‑office executives told Cerulli that once an ETF share class exists, firms will have to justify keeping clients in higher‑cost mutual fund share classes, especially if the ETF class is 10–15 basis points cheaper and more tax‑efficient. Some foresee pressure to “hard close” mutual fund share classes or avoid “clone” products altogether to reduce litigation risk.
Economically, Cerulli estimates that high rates of conversion to ETF share classes could put up to $30 billion of annual 12b‑1 and sub‑TA revenues at risk for the broker‑dealer industry, forcing new revenue‑sharing models that could erode the ETF’s low‑cost advantage.
RIAs open but not clamoring
Among RIAs, the tone is more measured than enthusiastic.
Kevin Grogan, chief investment officer of Systematic Strategies at Focus Partners Wealth, said his firm is “more or less indifferent” between standalone ETFs and ETF share classes, pointing to Vanguard’s history as proof that the two can deliver comparable investor outcomes.
“If you look at the Vanguard experience, their [ETF share classes] have similar tax efficiency as standalone ETFs,” he noted.
Looking across the RIA community, Grogan expects most firms would be open to dual‑share‑class ETFs if the underlying strategy adds value and the structure doesn’t hit any snags. He also sees a practical benefit in offering the same strategy in both mutual fund and ETF form for clients with preferences for a particular wrapper.
At Fairway Wealth Management, a roughly $2.5 billion RIA firm that leans significantly on an indexing approach to investment, the main draws of dual‑share‑class ETFs are cost control and tax management.
“As part of our due diligence, we don’t just look at performance and expenses; we pay close attention to how funds are structured,” said Matthew Garrott, director of investment research at Fairway. “So ETF share classes are an important piece of that puzzle for us.”
For Garrott, Fuse’s finding that just 13% of advisors favor ETF share classes was surprisingly low, as “anything to reduce costs…is generally a good thing” for fiduciary RIAs.
Still, he does see limits. Capacity‑constrained active strategies – notably small‑cap stock pickers – may be poor candidates for ETF share classes because managers can no longer easily soft‑ or hard‑close the strategy, raising the risk of performance suffering as assets swell.
“If I saw one of our small-cap managers launch an ETF share class, I’d want to keep an eye on that,” he said.
Beyond that, he said the value of a more tax‑efficient wrapper could be negated if switching between share classes were to trigger large embedded gains.
“For clients that have a share class at a gain, even though the expense ratio might be lower…it might not make sense to move them over,” he said, arguing that the viability of dual‑share‑class ETFs hinges on whether exchanges can be structured in kind to avoid taxable events.
While the benefits of ETF share classes have yet to be proven, Garrott maintains that RIAs with their client’s interests in mind have a duty to at least watch the space.
“From a fiduciary standpoint, if it’s better for the client, you have to be open to this,” he said.