US SEC readies relief for asset managers to add ETFs to mutual funds

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By Suzanne McGee and Chris Prentice

(Reuters) -The U.S. Securities and Exchange Commission paved the way on Monday for an asset manager to add exchange-traded share classes to mutual funds, a move expected to kick-start approvals for dozens of applicants, spark more ETFs and make the products more accessible to retail investors. 

The planned order, which is open for public response before the SEC moves ahead, is specific to Dimensional Fund Advisors and allows the asset management firm to launch the new share class. It has been long-awaited by the investment industry.

Monday’s notice is expected to throw open the gates for others. The agency gave Vanguard permission to pioneer the dual-share class model more than two decades ago under a patent that expired in May 2023. 

“This will be a key milestone for the industry,” said Todd Rosenbluth, head of research at TMX VettaFi. “There is no turning back.”

Under the change, a mutual fund could offer investors the opportunity to participate in its investment portfolio in the form of an exchange-traded product, known as an ETF share class.

Investors would be able to buy and sell the exchange-traded mutual fund shares throughout the day at the market price through their brokerage accounts, rather than waiting for a mutual fund order to settle at the day’s closing price. It has the potential to open up access to a host of existing funds to investors who prefer owning ETFs because of their low cost, tax advantages or liquidity.

“We see this as a win,” Brian Daly, director of the SEC’s Investment Management Division, said in an interview with Reuters. “We are increasing choice. We are reducing expenses. We are increasing tax efficiency, and we are making the innovation of the ETF – which is now decades old – more accessible to the average retail investor.”

Gerard O’Reilly, co-CEO at DFA, said in a blog post it puts the fund industry at the “forefront of a revolution.”

SEC staff plans to convene a conference call on Monday afternoon with other asset managers that also are hoping to win approval to offer ETF share classes, said Alex Morris, chief investment officer at F/m Investments and two other individuals who declined to be named.

“They will give us guidance on next steps,” Morris said.

Offering different share classes of the same mutual fund is not new. Currently, these may target different investor groups or carry diverse fee structures.

But the change will blur the line between exchange-traded funds and traditional mutual funds. A number of asset managers are likely to follow DFA and add ETF share classes to their top funds, ultimately triggering a surge in the number of new exchange-traded products vying for investor dollars.

Currently, an asset manager that wants to offer an ETF has to do so from scratch. That has meant designing a new fund and filing with the SEC for permission to launch. A new fund could not cite the mutual fund’s track record in marketing documents. 

“This makes it much easier for mutual funds to compete head-to-head with ETFs, because they won’t have to wait two or three years to acquire a track record and gather assets slowly over that time,” said Brian Murphy, a partner in the investment management practice at Stradley Ronon, who worked on several of the share-class filings submitted to the SEC. 

WAITING IN WINGS 

The approval came faster than the industry had expected. In mid-March, then-acting SEC Chair Mark Uyeda told an ICI meeting that he had directed the commission’s staff to move swiftly, surprising many asset managers and their advisers who had not expected movement before 2026.

There are now about 80 applications similar to Dimensional Fund Advisors’ to launch an ETF share class for existing mutual funds, the SEC said. DFA, the first firm to file with the SEC after the expiry of Vanguard’s patent in 2023, amended its application for a third time on Friday, containing final modifications sought by regulators.

The SEC’s order would include safeguards aimed at reducing conflicts of interest between the classes and ensuring proper disclosures to investors, said an SEC official.

The first approval is “the biggest step and biggest lift,” said the official, who said the process is expected to move quickly for others. 

(Reporting by Suzanne McGee and Chris Prentice; Editing by Megan Davies, Cynthia Osterman, Leslie Adler and Nick Zieminski)