Can Van Eck copy Vanguard’s one-of-a-kind fund structure without an army of lawyers?
Van Eck Global, the New York-based fund provider behind the Market Vectors ETFs, is looking to have the option of making ETFs into a share class of its mutual funds—a move that could put it into conflict with Vanguard, the only fund firm whose exchange-traded funds are a separate share class of its mutual funds.
Indeed, Vanguard has a patent that protects its structure under which it can offer ETF share classes of its existing mutual funds. Vanguard, which launched its first ETF under the structure in 2001, is now the No. 3 U.S. ETF company, with more than $200 billion in assets. The patent is said to be in effect until 2019.
One important reason why Van Eck would want to adopt a Vanguard-like approach is that combining ETFs with existing mutual funds creates larger economies of scale, meaning fund sponsors can charge investors in any share class less because the costs of running funds is spread across more assets and shareholders.
It’s unclear at this point if Van Eck’s move would infringe on Vanguard’s patent, or if Valley- Forge, Pa.-based Vanguard has licensed or otherwise granted some type of approval for Van Eck to proceed with its regulatory filing to gain permission to offer ETFs as a separate share class of its mutual funds.
Officials at Vanguard and Van Eck declined to talk about the filing.
The Vanguard Precedent
It appears from the filing that existing Van Eck ETFs would remain part of a stand-alone share class and that the question going forward is whether future ETFs would end up being separate or folded into the new proposed structure.
“Applicants seek an order to permit certain funds of the trust to offer ETF shares as a separate share class as well as one or more classes of conventional mutual fund shares,” the filing with the Securities and Exchange Commission said.
Whatever the backdrop and potential legal tangle ahead, Van Eck said in the filing that Vanguard was the germane precedent as the new petition wends its way through the SEC.
“The relief requested in this Application from sections 18(f)(1) and 18(i) is similar to the relief granted by the Commission to the open-end management investment companies issued by Vanguard Index Funds," the Van Eck filing said.
An added bit of intrigue is that one of the lead attorneys whose name is on the filing, Stuart Strauss of Dechert LLP in New York, also worked with Vanguard on its petition with the SEC, according to ETF industry sources.
That just might suggest that the two firms are cooperating though, as noted, officials from both companies wouldn’t comment on the filing.
Almost The Same Thing
An ETF share class of a particular mutual fund essentially offers an investor exposure to the same portfolio of holdings that a holder of that mutual fund would own, a point Van Eck made clear in the filing.
“The ETF shares and mutual fund shares will each represent interests in the same portfolio of investments,” Van Eck said in the filing.
But ETF expense ratios are typically lower than of mutual funds. That’s true at Vanguard, though expense ratios of its “Admiral” class of mutual fund shares, which require a minimum investment of $10,000, are on par with those of its ETFs.
"We tend to be fairly agnostic about this, in the sense that different investors like different things," Rodney Comegys, an executive at Vanguard's Equity Investment Group, said in a telephone interview.
"They are really two different doors to the same end result," Comegys added, referring to mutual funds and ETFs.
ETFs also have intraday tradability—which is mostly considered an advantage over mutual funds—and the Van Eck filing singled out tradability as one aspect of ETFs that investors favor.
A notable exception to that prevailing view is held by John Bogle, Vanguard’s founder, who considers trading to be a fool’s errand that hurts investors, save for those few who happen to get lucky with the timing of a trade or two.
Convertibility Of Mutual Fund Shares
In the filing, Van Eck said that under the structure it is filing to adopt, shareholders of mutual funds will be able to convert their holdings into ETF shares in tax-free transactions. However, it stressed no shareholders will be required to do so.
It also said such conversions would be one-way, meaning that ETF shareholders wouldn’t be able to convert their shares into mutual fund shares under the conversion option Van Eck is laying out.
One of the questions left unanswered in the filing is how Van Eck’s actively managed mutual funds would be handled if and when ETF share classes of the funds are brought to market. After all, Van Eck’s Market Vectors ETFs and the four ETNs it markets are all index strategies.
Van Eck has ETF assets of about $26.5 billion in more than 40 funds. Vanguard has 64 exchange-traded funds and total ETF assets of $200.46 billion, according to data compiled by IndexUniverse.