TAX PLANNING
to 13 existing mutual funds.“ The joining of mutual funds and ETFs through share classes represents a significant enhancement in how millions of Americans can access financial markets in the future,” said Gerard O’ Reilly, Dimensional’ s co- CEO and co-CIO.“ Share classes allow investors to choose the investment strategy that best suits their needs as a first-order consideration, and then select their ideal wrapper to access that strategy, while broadening benefits of increased tax efficiency and reduced costs from scale.”
In December of last year, the SEC followed up by granting similar approval to 30 more asset managers, including Black- Rock, J. P. Morgan, Pimco and State Street Investment Management. distribute the gains to all shareholders, even those who didn’ t redeem, triggering an unexpected tax bill.
In this case, the mutual fund shareholders who stuck around got left with a tax bill because of the actions of the exiting shareholders— hardly a fair reward for being a long-term investor. That sort of headache doesn’ t happen with ETFs.
If it had been an ETF in this case, the same 20 % of redemptions would be processed by what the fund industry calls“ authorized participants”( large financial institutions that have special arrangements to create and redeem shares directly with the issuer). By executing an in-kind transfer of underlying shares to these authorized participants( including
In 2023, Vanguard’ s exclusive ownership of the dual-class structure expired. With that barrier gone, other fund companies can now append ETF share classes to their own existing mutual funds, improving the tax efficiency for their own shareholders. benefits as well.
One of these is economies of scale. Since all the share classes in the overall fund structure have a single, shared portfolio of assets, the fund management is greatly simplified. In some cases, the fund’ s operations can be eliminated or consolidated. Administrative costs can be spread across a larger asset base, too, thereby streamlining the fund’ s overall costs. That can lead to lower expense ratios and thus better sustained performance.
Meanwhile, existing mutual funds with strong active management and performance history don’ t have to invent a separate fund. They now have a direct gateway into the ETF marketplace and their proven strategy now offers intraday trading benefits to investors.
A notable milestone in this evolution is DFA’ s launch of actively managed ETF share classes. This development is poised to open access to proven portfolio managers and investment strategies that had previously been confined to mutual funds— and bring new opportunities to ETF investors seeking active exposure in a more tax-advantaged format.
Taxes and Fund Investors
But this isn’ t just good for the fund industry and its product development. Again, it will also unlock tax efficiency for investors.
To understand why, let’ s examine a hypothetical case. Suppose an ETF and a mutual fund own the same basket of large-cap stocks— including Apple, Microsoft and Amazon. Now suppose the value of Apple stock has doubled over several years. How would a market crash affect fund shareholders in this case?
If we’ re talking about a mutual fund, let’ s say 20 % of the fund’ s investors decide in a panicked rush to exit the market by redeeming their shares. To meet redemption requests, the fund is forced to sell Apple stock to raise cash. The sale of those appreciated shares would trigger realized gains. In turn, the fund would the highly appreciated Apple stock), the ETF is able to legally skirt taxes. Why? Because the transfer is not considered a sale by the IRS, so the fund has zero realized capital gains and has made zero tax distributions to ETF shareholders.
In the Vanguard model— i. e., the“ ETF share class of a mutual fund” structure— the ETF share class can offload gains in a tax-efficient way, benefiting all the share classes, even those of the mutual fund. In effect, the ETF share class helps purge capital gains from the fund via in-kind redemptions. This can lower the tax drag for investors in both the ETF and the mutual fund.
Better Fund Management
But this structure means more than a better tax experience for fund shareholders. The multi-class structure offers other
Beyond the Vanguard
Now that the dual-class structure is no longer exclusive to Vanguard, the entire fund industry and its millions of shareholders can benefit.
In essence, the SEC’ s recent green-lighting of so many new market entrants creates a new era where a single fund portfolio can serve both traditional mutual fund investors and modern ETF investors seamlessly. It’ s a win-win for financial advisors, too. It will allow them to streamline their clients’ portfolio implementation while expanding access to tax-efficient strategies that better serve those clients for a variety of account types.
RON DELEGGE II is the founder of ETFguide. com and author of several books, including Habits of the Investing Greats and Portfolio Architecture: A Handbook for Investors.
48 | FINANCIAL ADVISOR MAGAZINE | JANUARY / FEBRUARY 2026 WWW. FA-MAG. COM