Dimensional Seeks ETF Creation Using Vanguard Mutual Fund Model

The firm hopes to use structure that had been Vanguard’s exclusive right.

Dimensional Fund Advisors is seeking permission to create exchange-traded fund shares out of its mutual funds, using a structure that had been exclusively Vanguard Group’s before the asset management behemoth's patent expired this year. 

Dimensional, which manages $614 billion, mostly in several dozen mutual funds, applied with the Securities and Exchange Commission to implement a fund structure that Vanguard had used exclusively from 2003 through this May. This would allow the Austin-based company, which manages $93.8 billion in 31 ETFs, to offer the tax benefits of ETFs for its already existing mutual fund products.  

Dimensional is the first company seeking to create the ETF share class since Vanguard’s patent expired. 

“We've always been the type of manager to not just launch products to gather assets, but we launch products based upon client demand and honestly where we think we can win,” Dimensional Senior Portfolio Manager Joe Hohn told etf.com. 

Vanguard Patent 

Asset management giant Vanguard was the first and, so far the only, firm to successfully implement the model.  

In 2000, the SEC gave Vanguard an exemption from regulations in the Investment Company Act of 1940, which enabled the firm to issue ETF shares for its existing mutual funds. The investment firm then patented the structure in 2003. According to Bloomberg, the move added $100 billion in gains to Vanguard shareholders.  

Since Vanguard’s patent expired on May 16, it has remained unclear whether the SEC will give another firm the exemption to pursue the structure.  

The only other firm to apply to the SEC for an exemption has been Australia’s Perpetual Group’s U.S. arm. The regulatory body has expressed concerns that the structure relies on ETF shareholders subsidizing mutual fund shareholders.  

Dimensional says it’s confident it can prove to the SEC the model would be beneficial to all shareholders equally. They say in the filing that the structure would also benefit ETF holders with perks like more efficient rebalancing and using mutual fund cash flows.  

“We can look and say, ‘Hey, SEC, thank you for having these concerns, but for us, they shouldn't be concerns, and we think we can answer those questions for them,” said Hohn. 

The latest move is a part of Dimensional’s broader strategy to tap into growing demand for active ETFs. Since debuting its first ETF in 2020, it has converted about $40 billion from mutual funds to ETFs. The firm, founded in 1981 by David Booth, is the largest issuer of active ETFs, according to Bloomberg.  

Hohn said that just because the structure is based on Vanguard’s original patent, Dimensional’s strategy, if the model is approved, would be unique.  

“When you get to the implementation, we are a heck of a lot different than what Vanguard is doing—they are an indexer; we are active,” explained Hohn. “We are using our flows, be it in our ETFs or in our mutual funds, to actively rebalance and actually increase the expected returns of those funds.” 

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