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

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 if they meet certain guidelines. 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.

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.”

“We are enormously pleased,” said Gerard O’Reilly, co-CEO at DFA, in a blog post that described the move as a “win for investors.”

“We could be at the forefront of a revolution in the fund landscape.”

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.

There are 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 first approval is “the biggest step and biggest lift,” said an SEC official. The others will largely track DFA’s, and the process is expected to move quickly for others, the official said.

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

Initially, only a handful of asset managers sought the go-ahead from the SEC to offer an ETF share class after the expiry of Vanguard’s patent, with 12 filings submitted by September 2023.

In mid-March, then-acting SEC Chair Mark Uyeda told an ICI meeting that he had directed the commission’s staff to prioritize their review of the applications, surprising many asset managers and their advisers who had not expected movement before 2026.

“What was slow is moving at light speed,” Joe Mannon, chair of private fund formation for law firm Vedder Price, told an ETF conference in Las Vegas in March.

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