For more than two decades, Vanguard has been the only asset manager to offer special share classes of mutual funds. Now, everyone is trying to get in on the fun.
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What was once Vanguard Group’s advantage — fund structures that allowed the firm to defer capital gains taxes and pass on big gains to its clients — could soon be extended to a broad swath of the asset management industry, including active managers.
There are 53 fund shops, collectively representing trillions in assets under management, asking permission from the US Securities and Exchange Commission to tack on classes of mutual fund- or exchange-traded fund shares using a multi-share class structure. Some might liken it to a queue or the starting line of a race — it’s more akin to a mosh pit because registrants aren’t necessarily trying to one-up each other but instead slam-dancing against the convention that mutual funds and ETFs remain separate.
Vanguard Effect?
Juggernauts like BlackRock, Fidelity Investments, State Street Global Advisors’ SPDR Series Trust, bond specialists DoubleLine and Pimco, and large and small active shops JPMorgan, Dimensional Fund Advisors, T. Rowe Price, and Akre Capital Management are in the mix.
Many want to add ETF shares to their mutual funds, and a smaller number wish to add mutual funds to their ETFs. Some want to do this for index-based funds, and others solely for actively managed ones. The majority of registrants want the flexibility to go either way — 30 shops, or 57% of applicants, want both mutual fund and ETF shares, and 36, or 68%, are active/index-agnostic, according to law firm Stradley Ronon’s analysis of pending applications as of March 25.
Investors stand to benefit from a multi-share class structure. According to filings from various fund managers, in-kind transactions through ETF shares may lower portfolio transaction costs and reduce unrealized capital gains for mutual funds. They also say that mutual funds, assuming they have the assets and a marketable track record, could help scale ETFs.
Fund managers told The Daily Upside the potential benefits of such an approval:
“We believe the ability to offer both mutual fund and ETF share classes in certain funds could enable more investor choice and provide lower transaction costs, tax efficiencies, and benefits of scale to all shareholders,” DFA co-CEO Gerard O’Reilly said in an email.
“Our low-turnover investment process has inherently been tax efficient over the years,” Akre Capital chief John Neff said. “The potential addition of an ETF share class within the Akre Focus Fund may provide even more enhanced tax efficiency for shareholders.”
Many firms asking the SEC to provide so-called exemptive relief from the 1940 Investment Company Act and related rules in order to offer such structures aren’t tracking Vanguard’s relief to a T.
“One of the big reasons that Vanguard’s relief only applied to index funds was because Vanguard’s specific exemptive relief did not require them to have full portfolio transparency,” Jeremy Senderowicz, partner resident at Goodwin law firm, said in an interview with The Daily Upside.
“Most of the 50-plus applications that have been filed do not ask for that,” he said. “They volunteer that funds with an ETF share class would have full portfolio transparency daily.”
Only four fund shops ask to go the semi-transparent route: Natixis, T. Rowe Price, Thrivent Mutual Funds, and Tidal ETF Trust. There hasn’t been any indication from the SEC that it would limit relief to index strategies, though the regulator has previously denied Vanguard’s 2015 request to expand the scope of its relief to actively-managed funds.
A Changed Fund World
The sudden wave of asset managers seeking exemptive relief to offer a multi-class share structure could be explained by the calendar — Vanguard’s patent expired in 2023. It could also be a virtue of the existential threats posed by the much-changed fund world.
When the Malvern, Pennsylvania-based fund debuted its unique structure in 2001, the ETF industry was still small, and active ETFs weren’t on the map. At the end of 2024, ETFs commanded nearly $15 trillion in assets under management, and active ETF flows pushed the category to top $1 trillion.
“Between 2002 and now, we’ve seen a consistent erosion of actively managed mutual funds market share, particularly in the equity space. The trend has been going on in the fixed income space for a good while as well,” Elisabeth Kashner, FactSet’s director of global funds research, said in an interview with The Daily Upside.
“The entire mutual fund business that was built on relatively high cost, actively managed products has really been shrinking, and a lot of the reason that any assets are sitting there at all is the tax consequences of selling,” she added.
In other words, for active fund managers facing a significant threat to their mutual fund business, ETFs are a way out. (A Ropes & Gray report on share-class structures said it expects exemptive relief from the SEC to allow what is called “exchange privilege,” which would permit holders to exchange their mutual fund shares for ETFs tax-free.)
What’s tougher to extrapolate from recent trends is pricing power and who has it. In a 2024 ETF Insight report, Kashner highlighted an ever-so-slight uptick, or 0.003%, in the asset-weighted average cost of US ETFs to 0.18% — a level last seen in early 2022 — after a decades-long trend of decline. The increase was attributable to the fixed income category as a result of actively managed funds, which tend to cost more, taking greater market share and dampening the fee-compressive effect of index-bond funds.
The report also noted investors’ “champagne taste” in active equity. Actively managed equity ETFs with an asset-weighted average cost of 0.41%, or 41 basis points, gained market share, while those that cost less, or 0.34%, or 34 basis points, lost market share.
“What asset managers are banking on, that we’ve seen a little bit of in 2024, is the belief that investors are willing to pay for performance, so long as you have a product that is outperforming net of fees,” she said.
New Frontier, New Sheriff
While there hasn’t been much movement on the regulatory front since the first handful of applicants submitted their filings in 2023, recent remarks at an investment conference in San Diego renewed hope that approval is a matter of when, not if. SEC Acting Chair Mark Uyeda said that he directed commission staff “to prioritize their careful review of the many applications” filed at the agency.
An outstanding question is what route the SEC will take in handling the many applications asking for exemptive relief. Some think approvals will be handled in batches, dealing with the simplest requests and then moving on to the more complicated.
Others wonder whether the regulator could propose a rule because an SEC official in a panel following Uyeda’s speech at the same conference said that rulemaking would make sense when lots of people are asking for the same thing. Recall, when the ETF Rule was adopted in the summer of 2019, it left out multi-class share structures.
When asked whether a rule was possible, an SEC spokesperson declined to comment beyond what SEC officials said at the conference.
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