A new report from market research firm Cerulli Associates highlighted some of the challenges facing the adoption of a dual class structure for exchange-traded funds.
While a vast majority of the nearly $10 trillion in total ETF assets as of late 2024 was parked in passive strategies, asset managers are increasingly using this investment vehicle to distribute active exposures, said the report, issued May 8.
Entitled ‘Dual-Share-Class ETF Challenges and Opportunities,’ the report noted that the greatest adoption for active ETFs has been in quantitative and derivative income-type strategies versus fundamental active products with a portfolio manager.
Citing data from ISS Market Intelligence Simfund. as of the end of 2024, Cerulli noted that ETF assets totaled about $9.45 trillion (including $866 billion in active strategies), up from $2.1 trillion ($24 billion in active strategies) as of the end of 2015.
The approval of dual-share-class product could give fundamental active managers the ability to gain scale in ETF products by attaching an ETF share class to an existing mutual fund product, Cerulli said.
This structure would allow the manager to transfer the track record of the mutual fund and avoid other hurdles in launching standalone ETF products.
However, Cerulli cited in the report, the most likely use case for existing mutual funds adding ETF share classes will be to allow existing mutual fund shareholders to benefit from the greater tax efficiency of ETFs.
Cerulli said that based on interviews with executives, they expect the U.S. Securities and Exchange Commission to “imminently approve” the 50 or so applications for dual-share-class exposures, with most firms seeking to add an ETF share class to existing mutual funds.
Prior to the 2024 presidential election, Cerulli said in the report, most firms expected approval of dual-share class products to come sometime in 2026 at the earliest. However, that timeline has accelerated, and many now expect approval to come as early as June or July.
“It’s due to a number of things, not the least of which is a new SEC administration, but also just the sheer inertia behind it,” the general counsel of a large asset manager told Cerulli.
However, some industry executives also cautioned Cerulli that some filing firms should have been more cautious, as neither intermediaries nor service providers are ready to support the fund structures.
While there are numerous challenges facing the adoption of of dual-share-class product, Cerulli believes the most significant are the apprehension by intermediaries regarding regulatory issues as well operational complexities associated with the exchange mechanism.
“If intermediary firms are not willing to adopt such exposures on their platforms, it will meaningfully delay dual share-class product adoption,” Cerulli warned in the report.
It’s also possible that some asset managers who launch such products will be playing a risky long game.
“Because we have a mass asset manager community that has filed and formed a joint push, once it gets materialized amongst financial advisers and clients, it’s going to be very hard for us to hold the line,” a wire house executive told Cerulli.
“If you talk to five broker dealers, you’re going to get five different answers for how they will handle the product offering; some will block; some will allow an ETF share class in brokerage, etc. – I’m not sure how long you can hold that line.”
Cerulli said conversations with intermediary executives across the wire house and broker-dealer channels highlighted a hesitancy for dual-share-class products and significant concerns for how these would function, given the complexity of the operational challenges.
“We’re still grasping at straws in terms of how we justify an ETF share class because we still haven’t been able to have the fund sponsors answer the question of purchasing an ETF share class of a mutual fund versus buying an ETF outright,” a broker-dealer home-office executive told Cerulli.
The dual share class was until recently only offered by Vanguard Group through a patent that expired in 2023.
The dual-share-class structure allows a manager to offer the same exposure through a mutual fund and an ETF share class, essentially allowing an investor or their adviser to use their preferred structure and secure the benefits associated with it, including greater tax-efficiency.
While Vanguard has successfully used the structure, Cerulli noted, they have only used it for passive exposures.
