By Brian Jones
Recently I had the opportunity to speak with Ignites for its June 2025 series on dual share classes. For those getting up to speed on the topic, I recommend that series, as well as:
- Nicsa’s ETF Share Class Toolkit (April 2025)
- Cerulli and Nicsa’s “Dual-Share-Class Product Challenges and Opportunities” (May 2025)
Here, I’d like to offer a few brief thoughts on the topic that my colleagues and I have been thinking about.
- Operational challenges tend to resolve over time, so Reg BI and product economics are likely the main stumbling blocks.
My understanding is that Vanguard has long relied on multi-day, manual processes when an investor wanted to exchange mutual fund shares for ETF shares. Obviously, that’s not ideal, but I have complete confidence that the industry can and will work out more efficient, scalable approaches. Here at Envision, when an order to exchange mutual fund share for ETF shares is received, we have the ability to hold share for the exchange in a “Pending status” thereby making sure the share are still available once the actual settlement trade comes to the mutual fund TA.
Therefore, I fully agree with Cerulli’s conclusion that the bigger issues are regulatory and cost factors.
- Investors are going to have relationship questions.
There are a lot of “check-and-app” mutual fund customers out there. The ETF share class will only be available through a broker dealer who typically places the investor's account on a brokerage system that then are held omnibus with the mutual fund. For these mutual fund investors to migrate into an ETF share class implies the mutual fund is willing to let go of controlling the customer relationship in pursuit of greater scale. So, investors will now be dealing with a broker-dealer rather than directly with the fund and its transfer agent. And if they hold investments in two share classes of a fund, and don't consolidate them with the ETF share class broker dealer, the investor will be left figuring out who to call when they have a question about their investment.
For the industry, the economics of this model may be thorny, but I’m sure it’ll get worked out with time. For investors, it means new portals, new processes, and new people. That may place heavier than usual demands on B-D staff in addition to investors’ own financial advisors.
- Transfer agents for mutual fund and ETF share classes may be different.
TAs are going to have to communicate effectively when investors want to exchange mutual fund shares for ETF shares. ETF TA-to-Mutual Fund TA interactions are fairly uncommon right now. So, efficient methods of communication will need to be devised. That’s where open, flexible technology will be necessary to help the mutual fund and ETF transfer agents seamlessly connect.
- Fund families need to think carefully about the fund rules, because they will shape the operations and investor services.
Exchanges are likely to be tricky—at least for a while—but they are probably a driving reason for most firms’ interest in establishing an ETF share class. Fund rules as documented in the fund’s prospectus will ultimately govern how exchanges work. Cerulli’s expectation based on industry interviews is that rules are likely to accommodate mutual fund to ETF conversions but not vice versa.
This isn’t the only area where fund rules will shape operations. Another example is rights of accumulation (ROA), by which mutual fund investors are allowed to accumulate purchases to reach break points. Will the ETF shares be counted in that—with counting potentially across two different transfer agents—one of which the fund is holding an omnibus account for the broker dealer, or not? Will this lead to Level 3 accounting at both the mutual fund and broker dealer?
Closing thought
Things are moving quickly, and there are a lot of questions still to be answered. I think it’s likely that a few firms will move ahead swiftly if and when the SEC gives the green light—but more firms, and even many among those that filed already, will take things a bit slower.
Because we’ve worked with both ETF and mutual fund transfer agents for many years, we understand the operational challenges that will come with bringing together two different securities and their service providers under one roof. The need for open and adaptable technology to overcome data sharing issues will be primary in the success of the dual class structure.