SEC Opens Door to ETF Share Classes, Dimensional First in Line

The U.S. Securities and Exchange Commission has taken a decisive step toward reshaping the fund industry, signaling it will allow Dimensional Fund Advisors to offer ETF share classes of its mutual funds.

In a notice published Monday, the SEC said it intends to grant exemptive relief for Dimensional’s multi-class structure, where a single fund can issue both mutual fund and ETF shares. The move positions Dimensional to become the first asset manager outside Vanguard with the ability to run ETFs and mutual funds side by side in the same portfolio.

Mutual Funds Meet ETFs

The model, pioneered by Vanguard two decades ago, allows fund managers to maintain a single pool of assets while offering investors different access points. Mutual fund investors transact at net asset value, while ETF shareholders trade intraday on an exchange. 

ETFs have generally been more tax-efficient than mutual funds, because they can use in-kind redemptions to limit capital gains distributions.

With the multi-class structure, asset managers can potentially deliver the tax efficiency of ETFs to their mutual fund investors. Since Vanguard’s patent expired in 2023, almost 80 firms have applied to add ETF share classes to their mutual funds.

Hurdles Remain

While the regulatory path is clearer, industry research suggests implementation will not be simple. A June white paper from Ropes & Gray flagged unresolved challenges around technology systems, board oversight, and the mechanics of exchanging mutual fund shares for ETF shares.

Many of these processes are manual today, raising the risk of errors if firms try to scale the structure too quickly.

Cerulli Associates also warned that distributors and broker-dealers could be reluctant participants as an estimated $15 to $30 billion in annual revenues from mutual fund servicing and distribution fees is at risk if assets migrate into ETF share classes. As a result, platforms may resist widespread adoption.

What’s Next

For mutual fund investors, the potential benefits are significant. They could see improved tax efficiency if their funds add ETF share classes, though it will take time for fund complexes, service providers, and intermediaries to retool systems and processes.

If widely adopted, the structure could bring hundreds of existing mutual funds into the ETF market and narrow the structural gap between mutual funds and ETFs by extending many of the ETF’s tax advantages to mutual fund shareholders.

Dimensional, which converted some of its mutual funds into standalone ETFs in recent years, now has the first-mover advantage in testing the new model.