Dimensional files for Vanguard-style ETF share classes
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Dimensional Fund Advisors has filed an application to offer Vanguard-style exchange traded fund share classes on its US mutual funds in a move that, if approved, could mark the start of a revolution in the US funds industry.
“This is only the beginning of what I expect will be a rash of traditional mutual fund companies pursuing the ETF share class structure,” said Nate Geraci, president of the ETF Store, a financial adviser, adding that it would solve an “enormous problem” for traditional mutual fund companies with significant assets in retirement plans such as 401(k)s that do not use ETFs.
“Offering an ETF share class would allow them to maintain their retirement plan assets — where mutual funds are still the dominant vehicle — while also pursuing the much higher growth ETF market,” said Geraci.
Todd Rosenbluth, head of research at VettaFi, said: “Dimensional has quickly climbed the ETF leader board through conversions of mutual funds and the successful launch of low-cost active ETFs, but the ability to offer an ETF share class to their broader suite will make them an even larger player”.
Dimensional entered the ETF market less than three years ago and has seen jaw-dropping growth, becoming the largest issuer of actively managed ETFs. Its 31 ETFs have $95bn in assets under management.
At present, only Vanguard has permission from the Securities and Exchange Commission to offer the ETF as a share class structure, and the green light was only given to its passively managed index funds.
Vanguard’s patent for the structure expired in May, but Gerard O’Reilly, co-CEO and chief investment officer at Dimensional, said that the existence of the patent had never been the real hurdle preventing other asset managers from using the structure because they could always have licensed it from Vanguard.
“In terms of having ETF share classes, step one has always been the SEC not the patent,” said O’Reilly. “We’re hopeful that if enough folks raise their voice it will rise up in priority for the SEC.”
However, after approving Vanguard’s patented structure in 2001, the SEC appeared to get cold feet and in 2019 it raised concerns about costs that result as features of only one share class or another being borne by all shareholders equally.
“The challenge will be getting the SEC on board,” said Geraci.
Dimensional said it was certain it could demonstrate that its proposed structure will be of benefit to shareholders of both share classes.
In the filing it asserts that under the proposed structure, mutual fund class shareholders will benefit through lower transaction costs and greater tax efficiency, and ETF class shareholders will be able to benefit from more efficient rebalancing using mutual fund cash flows and lower total portfolio transaction costs, as well as benefits of scale.
The potential benefits of scale are what has made many industry participants sit up and take notice. Dimensional, which manages $614bn globally, is the second active fund manager to file for the patent, but it dwarfs the first applicant PGIA, the US arm of Australian fund manager Perpetual.
Perpetual is a minnow compared to Dimensional, clocking in at 234th in the latest global ranking of managers by assets compiled by Willis Towers Watson’s Thinking Ahead Institute, compared to Dimensional, which is ranked 45th.
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PGIA’s application for ETF share classes is initially for just seven Barrow Hanley ETFs. In contrast, Dimensional is seeking permission to offer ETF share classes for all of its 112 US mutual funds, representing $400bn in assets under management, although O’Reilly said the creation of share classes, if approved, would be decided on a fund-by-fund basis because the structure might not benefit some of the funds.
PGIA filed its application in February but said the SEC has delayed comment period for another 60 days. Despite the apparent delay in PGIA’s progress, Rosenbluth echoed Dimensional’s optimism that it could demonstrate the advantages to shareholders of both asset classes.
“I feel confident that Dimensional has gotten sufficient regulatory clarity to believe they will be able to move forward,” Rosenbluth said.
Geraci added that the current situation was not ideal. “It seems unfair allowing Vanguard to have a monopoly on this structure. Their patent is now expired. If the SEC doesn’t allow other issuers to leverage the share class structure, they’re essentially extending Vanguard’s expired patent.”