Are ETF Share Classes a Decade Late to the Party?

The announcement of ETF share class approvals set the industry abuzz this quarter, but will the structure actually make a difference for investors? And will they even care? ETF.com's Dave Nadig recently discussed with Todd Sohn of Strategas, Ben Johnson of Morningstar, and Tony Dong of ETF Portfolio Blueprint on the ETF Zoo. The following is a transcript of their conversation on ETF share class meaning.

Transcript

Nadig: Share classes, Ben, I couldn't even fit your whole list here. You're the only person I know who's actually tracking every funder of these things. But we've had some Twitter conversations about this, about whether or not share classes are really going to be a big deal in terms of asset flows next year. I'm kind of on the downside on this, Ben. I'm getting the sense you are too. Does anybody really think we're going to get a thousand share class launches next year that's going to be real money? Because I'm getting more and more skeptical the more time goes by. Anyone?

Dong: I think that the only thing for me that would drive this is if 401(k)s got ETFs. Then maybe. If that's not going to happen, then that's honestly like — it's been 20 years in the making. Vanguard's had it for 20 years. I think at this point we're just like, okay, it's finally happening, you know, whoop-dee-doo. Like, look, Fidelity could come out and launch an ETF share class of ContraFund tomorrow, and your average Zoomer investor will still buy YieldMax over it.

Nadig: Well, and they've already launched clones, right? I mean, you can already get Magellan in an ETF. So...

Dong: Exactly. And which is semi-transparent. That too. Like, they didn't wait. They got too impatient. They jumped the gun with semi-transparent, and now we have FMAG, we have Blue Chip Growth in semi-transparent. And now Fidelity's stuck in a tough position of, "Oh, how am I going to reconcile this? Do we just admit that this was a bad idea and redo it in an ETF share class? What about ContraFund? Do we launch an ETF share class of that? How are we going to — are we going to piss off all the people who've held it for 20 years in a 401(k)?" 

Now they've got an alternative, right? There's a lot of tough conversations that are going to be had in boardrooms. And unfortunately, I just don't think the average retail appetite is there for this. Maybe advisors, but like, dude, retail doesn't even know what a share class is.

Will Conversions Move the Needle?

Nadig: Yeah, it's got to be conversions. I mean, Ben, is the conversion really going to matter? People who are sitting on these, sitting on mutual fund shares to convert? I mean, you've been tracking this more than anyone I know.

Johnson: Yeah, I mean, we'll see, Dave. So, like 91 by my count, exemptive relief applications filed with the SEC in varying degrees of seriousness up and down that roster. There's certain firms, and certainly Dimensional is out in front, that have already filed prospectuses for 13 ETF-mutual fund mashups. But there's also a lot of work that has to be done further downstream to get the plumbing right, to take care of like the economics of all of this, because getting the plumbing right costs money. 

And then there's also the economic factor that we're already living through today with clones, which is for a lot of wealth platforms, clones are a non-starter because they've got existing mutual fund business that has dedicated line items that pay for revenue share. And the ETF revenue share topic, just generally speaking, is coming into ever-sharper focus. And the models that are emerging there, low and behold, look a lot like the good old models of yesteryear that have prevailed in the mutual fund space for a long time. So there's all these myriad factors to take into account. 

I think, you know, this is going to be something much more meaningful if we look back on it five years from now than when we sit here today. It's also an area where, frankly, we're just out of step with other major markets. Like, ETF shares have been a thing in Canada for ages. They've been a thing in Australia for a long time. They're taking hold in Europe. So it just provides optimality, but I don't think they're going to be every bit as fungible and fluid as investors ultimately need and want them to be to reap like the full benefits of this structure. And that may be a few years in coming.

Nadig: Todd, do you think anybody wants these other than the issuers? Like, I mean, does the Street really wants these? Because they're already feeling pretty capital-stretched.

Sohn: Yeah, well, that — someone was talking about that the other day, about there's just not enough actual activity from the market makers. 

Johnson: Yeah, Katie Greifeld at Bloomberg wrote it. 

A Disconnect Between Expectation and Reality

Sohn: Yeah, that's another whole other angle of this. I've traveled around a lot, and I bring it up, and depending on where I am, there's some nods like, 'Oh yeah, we've looked at that,' and there's some that are like, 'What are you talking about? I don't care.' And so I'm just wondering if this is one of those things where like the hype doesn't meet the expectation. Reality and expectation are just kind of unaligned. 

And I don't know, some of the conversations I've had, it seems like folks are getting more lukewarm on it because it's a big risk in terms of I think you're going to lose some fees, right? The fee pressure, and annoying clients that are out there. Kind of what Ben just said, much more eloquently than I can say it. So I don't know, I'm struggling with this.

Nadig: Well, I think the market will tell us. I'm definitely on the under side of the $50 billion in converted flow next year from it. And, you know, Eric, I think, has the high side of the trillion-dollar eventual flow, but even Eric Balchunas isn't putting the pedal to the metal right now. 

Sohn: Can I give you an analogy?

Nadig: Yeah, I like analogies. 

Sohn: It's like Avatar to me. Avatar 1 comes out, it was a big deal, and then we didn't get any Avatar for 15 years or whatever it is, and now, maybe it's that. It just reappears over a decade. Like, oh yeah, share classes! 

Nadig: All of a sudden we should care, like we should care about James Cameron. Okay, I like it.

Sohn: Yeah.

Follow along with the conversation from our full ETF Zoo podcast episode here.