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SEC approves pilot program for ETF share classes.
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Mutual Funds can now be traded as ETFs to increase liquidity and tax efficiency.
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Over eighty asset managers are waiting for approval to launch ETF shares classes.
A key SEC announcement will soon allow asset managers the ability to add ETF share class to existing mutual funds using a multi-share classes structure. Mutual fund managers can now offer ETF versions of existing funds without having to launch new ETFs.
Dimensional Fund Advisors, the first firm to test out this model, has filed for an exemption to allow its mutual funds to issue ETF share classes along with traditional mutual fund shares.
How ETF Share Class Work?
In this new model a mutual fund can hold one set of assets, but issue two different types of shares. One class trades intraday at the exchange, just like any ETF. The other class is still in its traditional mutual fund form and trades once per day, at its net asset values.
Investors have a choice. You can choose the ETF share classes for their liquidity, intraday pricing and tax features. You can also choose the mutual fund class, if you want to stick with the familiar daily redemption method. The same core portfolio is available in two ways.
The SEC’s proposed Order under the Investment Company Act Release 35770 expressly permits this, as a “Multi Class ETF Fund” can offer one or more ETF traded classes plus non exchange mutual fund classes.
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Why this is important for asset managers
The SEC has stated that this is only a pilot, or first step. DFA is the pioneer in this new framework and regulators expect other asset managers to follow. Around 80 similar applications have been submitted by other firms seeking the same relief to issue ETF shares classes for their mutual fund.
Many in the industry see this as a way for traditional investment firms, to compete with ETFs. This will allow them to capitalize on the performance of their existing funds while gaining ETF benefits.
It’s important to note that the SEC will demand safeguards against conflict of interest between share classes and disclosures.
The crypto and tokenized project industry has made a big step forward
ETFs are already used in crypto, such as Bitcoin and Ethereum ETFs. But if mutual funds could adopt ETF share classes that would reduce structural frictions for funds considering tokenized strategies or blockchain-based strategies.
If regulators permit ETF share classes to be added to mutual funds, managers can attach an ETF class into a fund that invests tokenized assets. This would streamline approvals and launch times and make it easier to reach investors with tokenized strategies.
ETF classes also benefit from redemptions in kind, which can reduce distributions of capital gains. This model is appealing to taxable investors, and relevant for crypto-funds in non-tax-sheltered account.
The SEC is yet to take any further steps, but this move could lead to new types of investment funds that combine traditional financial technology with crypto.
Related: SEC’s October calendar brings six XRP ETF verdicts in one week
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