1 Portfolio, 2 Formats: The Future of ETFs

Regulatory approval for mutual funds to offer ETF share classes and vice versa is expected in Q4, representing a key milestone for the asset management industry. This development will enhance investor choice by allowing access to strategies in either wrapper, facilitate tax-free conversions from mutual funds to ETFs for improved efficiency and potentially lower fees, and enable broader access to retirement accounts for ETF strategies. While some firms are poised for immediate adoption, many are anticipated to take a gradual, wait-and-see approach due to logistical complexities, leading to a phased increase in dual-class offerings through 2026.

Analysis

The asset management industry is on the cusp of a significant structural change with the expected fourth-quarter regulatory approval for dual-share class structures. This will permit a single actively managed portfolio to offer both mutual fund and ETF share classes, a milestone VettaFi anticipates will be a game-changer for investor choice. A primary benefit will be the ability for investors to execute a likely tax-free conversion of existing mutual fund holdings into more tax-efficient and potentially lower-fee ETF equivalents. While over 70 firms have filed for approval, the rollout is projected to be gradual, not a 'race out of the gate' like the spot bitcoin ETFs. Early adopters are expected to be firms like Dimensional Funds and F/M Investments, but the majority of asset managers will likely take a 'wait-and-see' approach until 2026 due to significant operational and logistical hurdles that funds and custodians must address. The change is mutually beneficial: it modernizes legacy mutual funds by granting them an ETF wrapper without sacrificing their track record, while also providing an on-ramp for innovative ETF strategies to access the vast 401(k) and retirement plan market, which has historically been dominated by mutual funds.

Key Decisions for Investors

• Proactively engage with asset managers to identify which of their mutual funds will be prioritized for dual-share class offerings and to understand their specific conversion process and fee structures.
• Review current holdings in actively managed mutual funds within taxable accounts to earmark candidates for potential tax-free conversion into more efficient ETF share classes upon availability.
• Monitor the operational readiness of brokerage and custodian platforms, as the practical implementation of conversions and trading for new share classes will be gradual and may not be universally supported at launch.
• Anticipate new investment opportunities within retirement accounts, as the dual-share structure will provide an entry point for innovative ETF strategies to become available in 401(k) and other plans.