In 2001, Vanguard patented a method for creating ETFs as a share class of existing mutual funds. It was an aggressive move that vaunted the company into becoming a top asset gatherer in the ETF market. But after two decades of having a competitive advantage that no one else in the fund industry enjoyed, the patent expired on May 23, 2023.

Since then, the fund industry has scrambled to gain regulatory approval of Vanguard’s ETF share class invention.

Major players including Fidelity, Dimensional Fund Advisors and Morgan Stanley have made their pitches to the Securities and Exchange Commission (SEC) along with a host of smaller asset managers. 

What’s driving this push for the ETF share class sleeve?

“I believe this trend will continue to accelerate due to several reasons, including instant scale, track record and superior structure,” said Mike Akins, a founding partner of Denver-based “Investors have spoken and ETFs are the preferred vehicle for a multitude of reasons but primarily cost, liquidity, transparency, and the big one, tax efficiency.”

A few years ago, the SEC hinted the fund industry shouldn’t rely on ETFs built as a share class of a multi-class fund as method for introducing new ETFs. The agency cited concerns about how portfolio costs would be handled.

For example, a mutual fund share class that experiences significant redemptions could trigger a wave of portfolio liquidations and a domino effect of higher transaction costs along with negative tax consequences for ETF shareholders.

Despite obstacles, the push for ETF rule changes has heated up to the point that even major stock exchanges are getting involved.

Cboe Global Markets has asked the SEC to allow asset managers to list ETF shares of existing mutual funds. If approved, it would lead to a wave of ETF listings, providing a boon to major stock exchanges like Cboe along with NYSE and NASDAQ. Cboe’s request has an SEC response deadline of late November.

"For issuers, it's a no-brainer. Adding an ETF share class of existing mutual funds is likely a cheaper and more efficient means of entering the space than launching a brand new product or even converting an existing fund to an ETF," said David Dierking, an ETF analyst at “Issuers such as T. Rowe Price and Franklin, who are major players in the mutual fund space but have yet to establish a significant footprint in the ETF market, should find this to be an attractive way to grow their footprints in the industry."

While fund companies can offer ETF clones of existing mutual funds, it still can’t beat the multishare-class structure when it comes to operational efficiency. The latter approach offers shared back-end operating cost, distribution cost and better tax efficiency for fund shareholders. 

Converting mutual funds to an ETF structure is another path for asset managers to quickly enter the ETF market. But up until now, conversions have been limited to smaller mutual funds with minimal retirement plan assets. This is due to the fact the industry’s 401(k) infrastructure doesn’t easily accommodate ETFs.

"The largest impact of ETFs in a multishare class format might be felt in the retirement plan space,” added Dierking. “Right now, mutual funds are still the primary option in most 401(k) plans. Growing the presence of low cost ETFs in these plans would be a huge win for investors."

Most analysts agree that any SEC approval allowing fund companies to use Vanguard's ETF structure will open the floodgates.

Another related trend is separately managed accounts (SMA) to ETF conversions.

Akins said, “Operationally it can be much more complicated but there’s a lot of money at play here and I believe it will be as big if not bigger than the mutual fund to ETF conversion trend.”

Ron DeLegge II is the founder of and author of several books, including "Habits of the Investing Greats" and "Portfolio Architecture: A Handbook for Investors."