ETF as a Share Class is Here, What is Next?

ETF Share Class Trends: What Investors Should Expect Next

The approval of exchange‑traded funds (ETFs) as a share class of mutual funds could reshape the investment management landscape by broadening access for asset managers and, ultimately, investors. That said, the structure brings new operational, regulatory, and tax‑management complexities. The first ETF share class of an existing mutual fund has now launched. Notably, the reverse is also allowed: an ETF can offer a mutual fund share class, and one issuer has recently introduced such a class for an existing ETF.

This change introduces new complexities and uncertainties that all stakeholders, including clients, advisors, and asset management firms, will need to address. To successfully navigate this changing landscape, stakeholders must clearly understand this development and strategic benefits, if any.

While this could mark a significant development for the industry, the most important factor remains the close partnership between asset managers and broker-dealers, working together in the best interests of end investors.

The Dual-Class Structure is Multifaceted

When ETFs were first introduced in 1993, they operated as standalone products, distinct from mutual funds and other investment vehicles. In a limited capacity, the ETF framework changed when the SEC granted the first exemptive relief to Vanguard in October 2000 allowing a dual-class model. The first patent filing was made in March 2001 and granted by the Patent Office in April 2005.

Possible Benefits Include:

• Mutual fund investors can benefit from the ETF share class structure potentially through improved tax efficiency, though that is not guaranteed. The ETF’s ability to process in-kind redemptions may help minimize capital gains distributions for all shareholders, including those in the mutual fund share class. Additionally, managing a single pool of assets can reduce operational overhead, which often translates to lower fees for the investor.
• ETF investors gain access to established strategies with proven track records and greater scale, as the share class leverages the history and assets of an existing mutual fund. ETF shareholders should be aware that large redemptions from the mutual fund share class, which are typically settled in cash, could potentially result in capital gains realizations that affect all shareholders, including those holding ETF shares. While the ETF's in-kind redemption mechanism may help mitigate this effect, the actual tax impact will depend on various factors including redemption patterns, portfolio composition, and fund management practices.
• Asset managers can streamline operations and potentially costs can be reduced by managing a single portfolio for both mutual fund and ETF share classes. This structure enables managers to extend successful strategies into the ETF market without launching entirely new funds, while also expanding beyond index-based and into active strategies. However, this is not without costs; firms must build processes to support this new structure.

Recent SEC Approvals Create a Runway for Growth and Innovation

By allowing Vanguard to operate with traditional and ETF shares simultaneously, the SEC effectively set a foundation to democratize the dual-structure model. The expiration of the Vanguard patent in May 2023 prompted a surge of issuers seeking approval to offer this structure while expanding it beyond index-based and into active strategies. More than 90 asset managers, including some without existing ETF businesses, have sought exemptions from the SEC, which would allow them to register funds with both mutual fund and ETF share classes. The SEC recently approved roughly 48 firms to offer the dual-class.

This wave of approvals may increase competition and expand investor access to established strategies within the ETF wrapper. Mutual fund providers without an existing ETF business may now reach a broader range of participants and make an imprint in the ETF ecosystem. Currently, there are more than 550 mutual fund providers, yet only 125 operate an ETF business.

Significant Operational Legwork Is Required

Despite the dual-class structure’s growth potential, operational integration and regulatory compliance pose challenges. Operational readiness among wire houses and broker-dealers is vital to support the unique features of dual-class funds, such as facilitating tax-free exchanges and ensuring accurate trade settlement. Successful implementation requires cross-functional coordination among asset managers, intermediaries, and service providers, as all participants face significant infrastructure demands.

Currently, the lack of an automated, industry-wide mechanism for mutual fund to ETF share exchanges, otherwise known as an “exchange privilege," forces administrators to rely on manual workflows. Fund administrators must restructure accounting and compliance systems and automate exchanges. While many distributors may initially hesitate to build out these capabilities, there may be a domino effect: once a few key players establish a footprint, others could follow. Simultaneously, custodians must modernize their systems to handle daily portfolio transparency requirements and the complexities of transactions across share classes. Market makers and Authorized Participants (APs) may also be constrained by the operational build. While the buildout costs vary, estimates are significant, and the market also must wait for the Depository Trust & Clearing Corporation’s (DTCC) solution described below to be able to scope the build, and based on where we are in the yearly budgeting process, this is likely at minimum is a late 2026 or 2027 implementation - and maybe even multi-year process.

The DTCC advanced standardization of pooled investment transaction processing, underscoring the need to automate mutual fund to ETF exchange privilege, strengthen settlement controls, and improve cross class transparency. Industry testing began in Q1 2026 and effective May 18, 2026, DTCC is expected to roll out an automated Fund/SERV solution to facilitate exchanges of mutual fund shares for ETF shares - creating a defined runway for parallel testing, certification, and staged cutover.

Among the challenges, none is more critical than ensuring equitable treatment for all shareholders as more firms adopt the ETF share class structure. Fund boards have the fiduciary responsibility of determining that the dual-class structure serves the best interests of each share class (mutual fund and ETF shareholders)and the fund as a whole.

Bottom Line: Dual Share Classes Have Potential But Not Without Major Hurdles

But for the structure to become industry standard, firms must first navigate operational and regulatory hurdles, including the buildout of the infrastructure necessary for seamless and equitable execution. They also will weigh the pros and cons to mutual fund and ETF shareholders to ensure that one class is not advantaged over the other.