The US Securities and Exchange Commission intends to grant Dimensional Fund Advisors the ability to offer ETFs as share classes of mutual funds, opening the door for widespread use of a tax-saving structure previously exclusive to Vanguard Group.
The decision is a potential watershed moment for US money managers, more than 70 of which have sought permission from the SEC to adopt the dual-class structure. ETFs have become the investment vehicle of choice for Americans over the last decade thanks to their favorable tax status and ease of use. They’ve attracted trillions of dollars in inflows while mutual funds bled assets.
The SEC published a notice on Monday saying it will grant so-called exemptive relief to Dimensional to offer dual share class funds unless the commission orders a hearing. It comes after Dimensional filed an amendment to its application on Friday.
“This is one of those things that sounds wonky but has potentially massive implications as millions of investors with trillions in assets sitting in mutual funds will now be able to access an ETF version of that strategy,” said Eric Balchunas, senior ETF analyst at Bloomberg Intelligence. “While there are some operational hurdles still, we see this is a new tributary of flows into ETFs.”
Regulatory approval would be a big win for asset managers seeking to shrink clients’ tax bills and expand into the $12.6 trillion ETF industry as mutual funds lose ground to the generally cheaper, easier-to-trade wrapper.
The novel fund design, where one share class of a mutual fund is exchange-traded, was invented by Vanguard more than two decades ago. Since the firm’s patent expired in 2023, nearly every major money manager — including BlackRock Inc. and State Street Corp. — has asked the SEC for permission to use the dual share class model.
“This relief hits the trifecta: it increases retail investment options, lowers costs and expenses for the average American investor, and advances innovation,” said the SEC’s Brian Daly.
Vanguard’s patent expiration proved to be just the first obstacle cleared for rivals. The bigger hurdle was waiting for the SEC to grant exemptive relief from current ETF rules to use the structure. Vanguard itself is part of the most recent round of applicants, as it has so far only received permission to use the structure in passive funds.
The SEC had been relatively quiet on the status of the applications under Gary Gensler’s leadership. Optimism grew in March when Mark Uyeda, the regulator’s acting chair at the time, said that he was directing the staff to prioritize a review of the “many applications.” Shortly after, Dimensional Fund Advisors became the first hopeful to file an amendment to its application, signaling further progress on the SEC front.
“Mutual fund-class shareholders could benefit through lower transaction costs and greater tax efficiency, while ETF-class shareholders could also benefit from more efficient rebalancing using mutual fund cash flows and lower total portfolio transaction costs,” Gerard O’Reilly, co-chief executive officer and co-chief investment officer at the firm at Dimensional, said in a press release.
The landmark regulatory shift is set to have wide-ranging effects on Wall Street, if fund firms add exchange-traded fund shares to mutual funds en masse. Some experts caution that the change could erode some key benefits of the ETF wrapper, especially if these hybrid funds face steep withdrawals during market meltdowns.
A study from research firm Cerulli Associates estimates that fund distributors like wirehouses and broker dealers risk losing between $15 billion and $30 billion a year in fees that they currently collect from the mutual funds if those funds convert into the ETF share class.
Still, the SEC’s potential approval could give a lifeline to firms whose mutual funds are suffering outflows as investors choose ETFs.
In 2024, mutual funds shed a net $451 billion, while their exchange-traded counterparts — which typically offer superior tax efficiency and liquidity — took in a record $1.1 trillion, according to data from Bloomberg Intelligence.
“Now that the SEC has signed off, the real work will begin. There’s matters of logistics, economics and the economics of logistics to attend to and it will likely be years before we see ETF share classes proliferate and become broadly and easily accessible via conversions of existing mutual fund share class holdings,” said Morningstar’s Ben Johnson.
With assistance from Rheaa Rao and Nicola M White.
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