On the same day of the five-year anniversary of Dimensional entering a competitive, rapidly evolving exchange traded fund business, the active ETF provider received an approval notice from the SEC granting the firm exemptive relief to offer dual share class funds. Their timing couldn’t be more auspicious. The move would essentially widen the bridge between ETFs and mutual fund investors. This would allow the latter to take advantage of the structural benefits of the former.
2025 saw a wave of new active ETFs hitting the market. So the interest could open the floodgates for other providers offering similar dual share class products to the masses.
“This is truly a key milestone for the industry, which is running out of firsts,” said TMX VettaFi’s Head of Research Todd Rosenbluth. “This year marks the second in a row that the ETF industry has surpassed $1 trillion in net inflows and seen an ETF cross the $100 billion asset threshold. We anticipate Dimensional will be the first firm to offer an actively managed ETF share class of an existing mutual fund. Demand for actively managed ETFs has never been stronger. And Dimensional has a proven track record of supporting the active ETF investor.”
‘A Significant Enhancement’
Vanguard was the first to pioneer this fund structure in 2001, which was patented until its expiration in May 2023. This structure allowed Vanguard to offer an ETF share class of an existing indexed mutual fund. By creating an ETF that tracked the same index, investors could choose which investment vehicle would be most optimal for them. For example, the Vanguard Total Stock Market ETF (VTI) is an ETF derivative of the corresponding mutual fund: the Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX).
As ETFs began to gain in popularity, other firms sought to convert their mutual funds to ETFs. But it typically involved a cumbersome process. The approval granted to Dimensional will change that. It will pave the way for other mutual fund providers to offer their own dual share class funds. The rush was already underway with over 75 asset managers filing applications with the SEC to use the hybrid structure since the patent expired in 2023, according to Morningstar.
As noted by Bloomberg News, ETF juggernauts like BlackRock and State Street were also seeking approval from the SEC to offer their own dual share products. Ultimately, it was Dimensional getting the initial green light from the SEC. Given its billions in AUM in ETFs relative to the trillions under BlackRock and State Street, it’s somewhat of a David-beating-out-Goliath story.
“The joining of mutual funds and ETFs through share classes represents a significant enhancement in how millions of Americans can access financial markets in the future,” Gerard O’Reilly, Dimensional’s co-CEO and co-CIO, said in the release. “Share classes allow investors to choose the investment strategy that best suits their needs as a first-order consideration, and then select their ideal wrapper to access that strategy, while broadening benefits of increased tax efficiency and reduced costs from scale.”
Benefits of Dual Share Class Funds
The prime benefit of offering dual share class models to investors is deriving the tax benefits inherent in the structure. In an ETF, this stems from the creation and redemption mechanism. Under an ETF, it must sell underlying securities in the fund to meet redemptions through an authorized participant (AP) or in ETF vernacular, perform an “in kind” transaction. Using this process, ETFs can offload securities with built-up capital gains without realizing a taxable event. This benefits ETF investors who don’t have to incur these capital gains taxes. That same advantage can now be extended to mutual fund investors in a dual share class model.
Of course, the benefits aren’t just a one-way street from ETFs to mutual funds. As Dimensional noted in a press release, the ETF share class can also benefit from the structural advantages of mutual funds. Such is the case when it comes to daily cash flows. The cash can be used for portfolio rebalancing while also adding additional flexibility for creation and redemption baskets that could lower portfolio transaction costs.
ETFs can benefit from the existing customer base of their mutual fund counterparts with already-established brand recognition. Existing mutual fund investors can seamlessly transition to the ETF share class if they so choose. That eliminates the need to sell mutual fund shares that could incur capital gains taxes.
Additionally, those with 401(k) plans could eventually see their investment options expanded. As Morningstar noted, options were relegated to just mutual funds, but a dual share class structure could open the door to more funds with ETF benefits.
“Popular funds in 401(k)s were captive to the mutual fund structure because they couldn’t convert into ETFs,” Morningstar said. “Likewise, if ETFs are allowed to add mutual fund share classes, then ETF providers will gain access to retirement plans.”
