Potential Benefits of New Mutual Fund Structure

Some mutual funds may soon become more appealing for investors. On September 29, 2025, the Securities and Exchange Commission announced plans to allow Dimensional’s mutual funds to introduce exchange-traded share classes. This marks a notable step, happening two years after Dimensional first sought approval.

While initial regulatory obstacles have been cleared, much work remains. Dimensional needs to implement and get the green light from the new board’s oversight process to ensure that these dual-share class funds serve investors effectively. Additionally, investment platforms and service providers will have to set up the necessary infrastructure for these new funds, especially if the systems haven’t yet been prepared for similar offerings like Vanguard’s.

Operational issues might delay rollouts for many new dual-class funds from over 75 firms, including Dimensional, which has applied for exemption relief. Although gaining approval for these share classes could significantly impact the fund industry, it’s likely going to take a while to see the results of these efforts.

Understanding ETF Share Classes

Typically, mutual funds allow investors to choose among various share classes. Vanguard initially enhanced this structure by introducing ETFs as a share class for the Vanguard Total Stock Market Index in 2001. This gave Vanguard clients the option to invest via mutual funds or ETFs. The unique arrangement provided the tax advantages of ETFs to mutual fund stocks. Since then, ETF share classes have been added to numerous mutual funds, each designed to track indexes.

Vanguard held a patent on this innovative ETF-as-a-share-class structure until May 2023, during which they could only use hybrid arrangements within index-tracking mutual funds. Over a two-and-a-half-year period, more than 75 asset managers approached the SEC to utilize this hybrid model.

Pros and Cons of ETF Share Classes for Investors

If applied correctly, ETF share classes can be advantageous for both investors and asset managers. The hybrid structure allows current mutual fund investors to gain access to ETFs’ tax efficiency. Funds introducing ETF stock classes are generally expected to offer “exchange privileges,” meaning investors won’t have to sell their mutual fund shares to invest in corresponding ETF shares—thus avoiding possible capital gains distributions and taxes. Essentially, the addition of an ETF share class lets investors benefit from the tax efficiency inherent in ETF redemptions.

Investors in mutual fund share classes could stand to gain the most. ETF share classes can help eliminate stocks and bonds with accumulated capital gains through a redemption mechanism. This hybrid approach keeps the ETFs aligned with the fund’s net asset value, helping to minimize potential capital gains distributions. It might be why Vanguard mutual funds with ETF share classes don’t often distribute capital gains.

ETF shareholders may also enjoy advantages from a dual-share-class structure. New ETFs linked to established mutual funds with solid client bases could prove useful right off the bat. The cash flow of mutual funds might also enhance the fund’s ability to adjust its portfolio, potentially lowering transaction costs.

However, these benefits come with a few trade-offs. ETF shareholders might still face taxes on capital gains and other distributions, unlike standalone ETFs. Certain situations, often triggered by investor behavior in mutual funds, can also impact ETF stock class investors negatively.

These occurrences are uncommon, though. A large outflow from mutual fund share classes, coupled with ETF performance and the overall increase in the fund’s assets, would need careful timing to trigger such distributions. To date, this situation has only happened once in Vanguard’s nearly 25-year experience with ETF equity classes, but it’s plausible that ETF investors might sometimes help subsidize mutual fund equity class investors who lean towards riskier, high-cost strategies.

Nonetheless, ETF share classes aren’t universally applicable across all mutual funds. Some active managers prefer to restrict new investor inflow as their funds grow larger. Since ETFs can’t do this, ETF share classes may bring unique challenges, especially since ETFs disclose their holdings daily—something certain managers feel might expose their investment strategies.

Motivations Behind Asset Managers’ Interest in ETF Share Classes

The mutual fund industry isn’t known for its unity, but over 75 firms have sought dual-share class structures. This includes leading ETF players like BlackRock and Vanguard, as well as firms without existing ETF offerings such as Baron Capital and Lord Abbett.

The primary reason for this collaborative movement within the fund industry likely stems from the growing investor trend towards ETFs. This shift enables mutual fund strategies to transition into ETF structures more seamlessly. Previously, asset managers faced a cumbersome process to create new, standalone ETFs or convert mutual funds into ETFs.

Popular funds, especially in 401(k) offerings, have been tethered to mutual fund frameworks, limiting their ability to convert to ETFs. If an ETF can incorporate a mutual fund stock class, it gains access to retirement plans.

A hybrid approach enables asset managers to provide investors with a one-stop solution that accommodates their preferred investment vehicles.

Looking Ahead

Dimensional is poised to be the first provider rolling out a new dual-share class fund. Still, widespread implementation faces several challenges. One significant hurdle is that ETF stock classes will need to be migrated away from certain platforms, which could limit their distribution in the near term. Moreover, Dimensional has various new procedures and reports to get approved by the funds’ board to satisfy the SEC’s new requirements for ETF stock class relief. Simply put, don’t expect these ETF share classes to launch immediately.

The future of the ETF landscape will hinge on how it adjusts to the influx of ETF stock classes. Given that Dimensional already leads in active ETF offerings in the U.S., adding a stock class could be an extension of their current capabilities. However, there remain uncertainties—new entrants will likely continue to develop ETF management skills, and a surge in new ETF launches might pressure market makers. Additionally, how the specialized transactions that provide tax efficiency will be funded is still unclear.

Ultimately, while ETF share classes present attractive new options for investors, it’s essential for them to evaluate whether the dual-class structure truly provides tangible benefits before diving in.