Vanguard Rivals Finally Get Hands On Its Tax-Busting Fund Design

For more than two decades, US money managers have looked on enviously as Vanguard Group reaped the benefits of a unique structure that grafted the advantages of an ETF onto its biggest mutual funds. The design, protected by patent, saved its investors billions of dollars and helped the Jack Bogle-founded firm grow into an $11 trillion giant.

Now, in what could be the most consequential shift in the American investment industry in years, Vanguard is finally set to lose that competitive edge.

Dozens of rival asset managers are on the brink of adopting the same structure, after the US Securities and Exchange Commission indicated it will allow the quantitative firm Dimensional Fund Advisors to do so in the coming weeks. Roughly 80 more competitors are in the queue for approval, including nearly every major name in the business. She speaks with Carol Massar and Tim Stenovec.

The model they want to follow creates an exchange-traded fund as one of the share classes of a mutual fund, a move that ports the famous tax efficiency of the younger structure to the older vehicle. Assuming the approvals come, it will likely trigger a wave of new ETF launches, re-write the tax and performance of countless mutual funds, and potentially finally erode the barrier that has until now largely locked ETFs out of the American retirement system.

“We already feel like we’re attached to a rocket ship, moving as fast as we can to launch more products,” said Brittany Christensen, head of business development and senior vice president at Tidal Financial Group, which helps create and run ETFs. “When I think about putting more fuel on that fire, that’s absolutely what this does.”

Technical challenges to implementing the new structure remain, so the landscape won’t alter overnight. And since most major money managers already offer ETFs — having long ago given in to investor demand for the easier-to-trade, often cheaper vehicles — some market watchers have questioned how many will actually deploy it.

But the size of the waitlist — more than six-times the number of firms that were racing for approval to launch Bitcoin funds — suggests huge industry-wide enthusiasm to take up the Vanguard blueprint. Eric Balchunas, senior ETF analyst at Bloomberg Intelligence, said it’s “like sitting on a bunch of CDs and here’s a chance to convert them all into digital.”

Waiting Game

Asset manager giants including BlackRock Inc., Fidelity Investments, T. Rowe Price Group and Franklin Resources Inc. are among the firms seeking regulatory permission to deploy the hybrid structure. Some have been waiting for about two years, ever since Vanguard’s patent expired.

In a virtual meeting on Monday, the SEC told pending applicants they should conform their filings to that of DFA’s, but did not provide guarantees on when they would sign off on the next applications, according to four people familiar with the matter.

BlackRock, Fidelity, Morgan Stanley and F/m Investments are among those that have already updated their paperwork.

“This is big for the T. Rowes of this world that don’t already have super well-established ETF businesses and they’re suffering outflows from their mutual funds,” said Adam Sabban, associate director, equity strategies at Morningstar Inc. While it’s unclear if it will help generate new inflows, “it could help them retain their current assets and slow the pace of outflows,” he said.

Some firms, including F/m, are looking to create mutual fund share classes of ETFs, opening the door for those products to break into 401ks. The pension system was built around mutual funds, and most platforms are not equipped to handle the intraday moves and liquidity of an ETF.

Advantage Vanguard

Unexpectedly, even the pioneer of the ETF-within-a-mutual-fund model is on the waitlist. Vanguard only has permission to use the structure on passive funds, so the firm is now seeking approval to deploy it in active products.

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