Trending
For many clients and retail investors, Vanguard is synonymous with low cost index funds and exchange traded funds and widely viewed as one of the primary architects of the fee-conscious, passive investing movement. Accurate approximations to be sure and ones that are confirmed by recent moves.
Unbeknownst to some investors, including some Vanguard devotees, is the fact that the Pennsylvania-based asset manager is also a force in the world of traditional mutual funds. It issues nearly 270 products, according to its website. That makes Vanguard a logical candidate to be among the fund sponsors asking the Securities and Exchange Commission (SEC) to approve ETF share classes of its various mutual funds.
That happened Wednesday, ending a period of pondering for fund industry observers that wondered why it took Vanguard so long to do so. After all, the company pioneered the idea of ETF share classes of other funds. The company did that with a slew of its index funds, holding a related patent that paved the way to become the second-largest U.S. ETF issuer despite a relatively late entry into the space.
That patent expired in May 2023, prompting a slew of Vanguard rivals to ask for regulatory permission for ETF share classes of previously existing active funds, ushering in a new mutual fund-to-ETF conversion cycle that is still in its infancy. Since that patent expired, more than 60 asset managers have requested permission to issue ETF share classes of their mutual funds.
Details on Vanguard ETF Share Class
This time around, is only asking the SEC to approve share classes of actively managed mutual funds. One of the motivating factors in these moves – one true of any issuer filing for ETF share classes – is the potential to dramatically reduce or eliminate capital gains distributions to investors.
“Vanguard and its competitors are keen to adopt the ETF share class to reduce potential capital gains distributions and move toward a vehicle that has become more popular,” notes Morningstar analyst Daniel Sotiroff. “Outflows have plagued actively managed mutual funds in recent years, and they show no signs of slowing. Those outflows can force managers to prematurely sell stocks and bonds with appreciated prices and realize capital gains, which they must distribute to investors at the end of the year.”
How ETFs are created and redeemed is a significant factor in why they’re more tax-efficient and less susceptible to capital gains distributions than active mutual funds. ETFs use daily in-kind transactions, which are not taxed.
Mutual funds cannot simply decide to move to in-kind transactions. If that was possible, issuers likely would have already done it. That is to say, broadly speaking, in order to gain the tax benefits afforded ETFs, the fund in question had better be, well, an ETF.
More Pros Than Cons in ETF Share Classes
ETF share classes of mutual funds aren’t perfect. ETFs are more transparent than mutual funds and some active managers might not like losing control of their “secrets”
Likewise, ETFs can never close themselves off to investors. That form of gatekeeping has been deployed by issuers of active mutual funds when managers believe the fund has gotten too big and that size adversely affects the manager’s ability to pick winning securities and generate adequate returns. If that’s a luxury, it’s one that won’t be available to ETF share classes. Still, there are more pros than cons with ETF share classes of mutual funds.
“That said, the benefits can outweigh the drawbacks. When applied to the appropriate mutual funds and managed prudently, ETF share classes are a positive development for investors,” concludes Sotiroff.
Related: Advisors Constructive on 2H 2025, See Value in Volatility