Numerous U.S. asset managers are preparing to create exchange-traded fund (ETF) share classes for their mutual funds, a process that raises logical questions such as the potential of this approach and the challenges its use might present, among others. A study by Brown Brothers Harriman (BBH) examines the pros, cons, and key considerations surrounding the introduction of these vehicles.
In the fall of 2025, the U.S. SEC announced a historic decision that should pave the way for fund managers to offer ETF share classes within existing mutual funds: it granted Texas-based investment firm Dimensional Fund Advisors the right to add ETF share classes to its mutual funds.
With this move, the SEC broke a long-standing market stalemate that could trigger a wave of new ETF share classes for mutual funds. Following this decision, more than 60 sponsors, out of the 80 that initially filed applications, have resubmitted requests for ETF share classes.
Why Now?
At BBH, they explain that the remarkable growth of the ETF industry has led many asset managers to explore ways to design and restructure their mutual fund lineups to offer the benefits of exchange-traded funds. Since the first mutual fund-to-ETF conversion in 2021, conversions have become an increasingly popular approach.
However, this process “can be complicated,” according to BBH, as in some cases “it presents limitations and complexities for distribution,” requiring brokerage accounts for all investors.
Advantages
Allowing a fund to offer both mutual fund share classes and ETF share classes could, according to BBH:
Promote tax efficiency.
Foster a more competitive market.
Enable providers to offer lower fees and real-time trading to clients, while also providing greater portfolio flexibility.
Expand investor options through the development of new products.
For sponsors, ETF share classes offer the potential to:
- Demonstrate a broader track record of performance and results.
Extend tax efficiency to a wider group of investors.
Optimize ETF baskets to improve liquidity.
Increase investor access to their investment strategies.
Leverage economies of scale.
Technical Details and Structural Contrasts
The SEC remains particularly focused on ensuring fair treatment for investors across all share classes within this new structure, specifically regarding the cross-subsidization of expenses and the overall tax impact for investors in a common portfolio of assets.
Since most retail investors buy and sell ETF shares from one another on the exchange, ETFs include a mechanism that protects them from a high volume of direct portfolio transactions. Unlike mutual funds, most ETFs can also reduce or eliminate the possibility of capital gains distributions through the in-kind delivery of securities—the mechanism used to create or redeem ETF shares directly with the fund, often referred to as the primary market.
The in-kind delivery process helps limit trading costs associated with portfolio management. In addition, any costs tied to cash transactions are typically reimbursed by an authorized participant. This contrasts with mutual fund portfolio management, where trading costs and taxes are inherent to the structure and shared by end investors.
Finally, ETFs are generally fully invested, whereas mutual fund managers often maintain a liquidity allocation to support efficient portfolio management and fund redemptions. This potential “cash drag” on performance introduces a unique variable when ETFs are part of a multi-share class structure.
Considerations for Launching Share Classes in the United States
1. Distribution: The commercial implications of this structure for a sponsor’s distribution strategy cannot be overlooked, as BBH points out. Distributor platforms “are already examining how to treat multi-share class structures,” where mutual fund and ETF share classes may raise conflicts under Reg BI.
The multi-share class structure promotes a product-agnostic distribution approach, “which offers investors a wide range of options.” However, the inclusion of ETFs may “introduce new channels or investor types (in addition to a new product category) for the asset manager, creating a need for training and education.”
Firms may also consider adding new sales support resources, such as ETF specialists, to provide their teams with in-depth ETF knowledge and effective guidance toward prospective clients in these new channels.
Existing sales compensation plans will need to be calibrated to properly incentivize ETF sales, taking into account the unique structure and distribution dynamics of exchange-traded funds. Sponsors should also carefully consider pricing in relation to other share classes and understand the potential uncertainty around duplicating an investment strategy—now offered as an ETF.
Lastly, conversions or exchanges (when mutual fund shareholders wish to switch to the ETF share class) involve operational complexities that currently lack an industry-wide solution. As BBH notes, due to this complexity, sponsors, distributor platforms, and administrators “will need to collaborate closely.”
2. Outstanding Tasks: To obtain approval, ensure effective implementation, and demonstrate sound governance after launch, the following objectives must be prioritized:
Developing an effective accounting allocation methodology for expenses and taxes at both the fund and share class level (where applicable)
Creating an initial adviser report outlining the expected benefits for investors across all share classes
Building a framework for ongoing governance oversight
Formal board oversight through regular reviews and reports evaluating whether the structure continues to serve the best interests of each share class. This will include analysis of factors such as trading costs, capital gains, and loss of liquidity.
