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A crop of new dual-share class funds — that offer different types of the same fund with varying fees, loads, and other features — may be on the way for financial advisors. More than 50 asset managers, including 10 since December, have already lined up to apply with the Securities and Exchange Commission for the so-called exemptive relief necessary to tack on the new exchange-traded fund share classes. While the details are a bit technical, (in plain English) it means financial advisors may soon have access to a much broader range of investments to offer their clients.

The funds that asset managers are looking to add share classes onto collectively manage trillions of dollars in assets, with most of the applicants seeking to add ETF share classes to mutual funds (just a few looking to do the reverse). This wider opportunity net might mean, for example, that an advisor who prefers a certain mutual fund’s strategy, but wants to use ETFs in client portfolios, will be able to access the strategy in their preferred format. On the other hand, the creation of mutual fund shares of an ETF could allow the strategy to gain access to mutual fund-only retirement plans.

What is certain is that dual share classes may fundamentally change how funds are created, used, and sold to investors. “Broadly speaking, this widens the opportunity set, and that should be a net positive,” said Brian Storey, Brinker Capital’s head of multi-asset strategies.

Playing Catch Up

Dual share classes actually aren’t new. Vanguard was first allowed to create an ETF share class of its mutual funds in 2000, with a structure that the asset management giant patented. After patent protection expired in May 2023, other asset managers began queuing up to copy the strategy. There’s little doubt that the SEC will approve requests for dual share classes — at least among asset managers. A Cerulli survey of ETF managers last year found that most expect mutual funds seeking to add ETF share classes will get the green light.

BlackRock, Charles Schwab, and Fidelity are just a selection of the top names that have already applied for exemptive relief. It’s difficult to say when the SEC might start adjudicating these requests, but acting chairman Mark Uyeda said in mid-March that he had directed agency staff to prioritize their review. And experts around the industry have already moved their expected timing for verdicts to late 2025, from previous expectations of sometime in 2026, said Cerulli Associate Director of Product Development Matt Apkarian.

Passive Aggressive. Asset managers want to create dual share classes of both passive and active funds — and that raises an interesting question for active fund managers. Mutual funds only need to report their holdings once per quarter with a 60-day delay after each fiscal quarter, which in theory prevents competitors from mimicking them. (The SEC will require larger funds to disclose monthly starting in November.) That competitive advantage disappears with actively managed ETFs, which are required to publish their holdings daily.

But shielding alpha, even in mutual funds, is already becoming futile. Most active mutual fund strategies are also offered in very transparent separate-account form, notes Apkarian. In addition, AI and machine learning are proving quite accurate at identifying the holdings within non-transparent funds, he adds. “Overall, the managers have to accept that their IP is out there,” he said.

Where’s My Taxes? For end investors, ETFs’ tax efficiency is an important advantage over mutual funds. Rebalancing through ETFs’ in-kind redemption mechanism means fewer or no capital gains distributions, for instance. But an even bigger advantage is available to investors on the mutual fund side of a dual share class, according to Morningstar analyst Daniel Sotiroff. In a 2023 article, he noted that the ETF share class can neutralize potential capital gains distributions by “cleansing” stocks and bonds with built-up capital gains through in-kind redemptions. This helps explain why Vanguard mutual funds with ETF share classes “seldom distribute capital gains,” he wrote.

On the other hand, if a mutual fund experiences significant redemptions and realizes capital gains, both the mutual fund and ETF share class investors may face capital gains distributions. That could come as a shock to investors who chose the ETF share class with the expectation of tax efficiency, said Brinker’s Storey. “As with everything, it’s not all roses,” he added. “But I think, net-net, this will be a real positive for advisors, investors, and the industry at large.”

For asset managers, there are some definite advantages to adding ETF share classes of a fund rather than launching a standalone ETF with the same strategy. They include lower costs, simplified regulatory compliance, and operational efficiencies. Most large legacy mutual fund companies have launched ETF versions of at least some of their funds, and for many that has served as an asset lifeline, helping them stay relevant as investor demands have changed. Betting on ETFs has certainly worked out for Vanguard: $2 trillion of its $10 trillion of assets under management are now in ETFs.