The U.S. Securities and Exchange Commission set the stage on Monday for an asset manager to incorporate exchange-traded share classes into mutual funds. This move is anticipated to kick-start approvals for numerous applicants, stimulate more ETFs, and make these products more accessible to retail investors. The proposed order, which is open for public feedback before the SEC proceeds, is specific to Dimensional Fund Advisors, allowing the asset management firm to launch the new share class. This development has been long-awaited by the investment industry, and Monday’s notice is expected to pave the way for others. The agency had previously granted Vanguard permission to pioneer the dual-share class model over two decades ago, with the patent expiring in May 2023.
“This will be a key milestone for the industry,” said Todd Rosenbluth, head of research at TMX VettaFi. “There is no turning back.”
Under the new change, a mutual fund could offer investors the opportunity to participate in its investment portfolio through an exchange-traded product, known as an ETF share class.
Investors would have the ability to buy and sell exchange-traded mutual fund shares throughout the day at market prices via their brokerage accounts, rather than waiting for a mutual fund order to settle at the day’s closing price. This has the potential to open up access to a variety of existing funds for investors who prefer owning ETFs due to their low cost, tax advantages, or liquidity.
“We see this as a win,” Brian Daly, director of the SEC’s Investment Management Division, said in an interview with Reuters. “We are increasing choice. We are reducing expenses. We are increasing tax efficiency, and we are making the innovation of the ETF – which is now decades old – more accessible to the average retail investor.”
Gerard O’Reilly, co-CEO at DFA, stated in a blog post that this puts the fund industry at the “forefront of a revolution.”
SEC staff plans to hold a conference call on Monday afternoon with other asset managers also seeking approval to offer ETF share classes, said Alex Morris, chief investment officer at F/m Investments, along with two other individuals who declined to be named.
“They will give us guidance on next steps,” Morris said. Offering different share classes of the same mutual fund is not a new concept. Currently, these may target different investor groups or have diverse fee structures.
However, the change will blur the line between exchange-traded funds and traditional mutual funds. A number of asset managers are likely to follow DFA and add ETF share classes to their leading funds, ultimately triggering a surge in new exchange-traded products competing for investor dollars.
Currently, an asset manager wishing to offer an ETF must start from scratch. This involves designing a new fund and filing with the SEC for permission to launch. A new fund could not reference the mutual fund’s track record in marketing documents.
“This makes it much easier for mutual funds to compete head-to-head with ETFs, as they won’t have to wait two or three years to establish a track record and gather assets slowly over that time,” said Brian Murphy, a partner in the investment management practice at Stradley Ronon, who worked on several of the share-class filings submitted to the SEC.
WAITING IN WINGS
The approval came quicker than the industry had anticipated. In mid-March, then-acting SEC Chair Mark Uyeda informed an ICI meeting that he had directed the commission’s staff to act swiftly, surprising many asset managers and their advisers who had not expected movement before 2026. There are currently about 80 applications similar to Dimensional Fund Advisors’ to launch an ETF share class for existing mutual funds, the SEC noted. DFA, the first firm to apply with the SEC following the expiration of Vanguard’s patent in 2023, amended its application for the third time on Friday, including final modifications requested by regulators.
The SEC’s order would incorporate safeguards to reduce conflicts of interest between classes and ensure proper disclosures to investors, said an SEC official.
The first approval is “the biggest step and biggest lift,” said the official, who indicated the process is expected to proceed swiftly for others.
