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October 27, 2023 at 12:52 PM
What You Need to Know
- Vanguard pioneered a dual-share structure over two decades ago, which helped its funds generate higher after-tax returns.
- While Fidelity has $36 million today in ETF assets, Vanguard has over $2 trillion
- Fidelity said portfolio managers in charge of funds with the dual-share structure could engage in some tax management.
Fidelity Investments is seeking clearance that would allow some of its best-known mutual funds to also operate as exchange-traded funds, becoming the largest firm to challenge Vanguard Group’s former monopoly on the concept.
The Boston-based firm applied Tuesday for a government waiver that would allow its actively managed mutual funds to also issue a separate class of ETF shares, according to a regulatory filing.
Vanguard pioneered and began patenting this dual-share structure more than two decades ago, which helped its funds generate higher after-tax returns and capture almost a third of the U.S. market for ETFs.
The last of its patents expired in May, providing firms such as Fidelity with an easier way to package their stock- and bond-picking strategies into ETFs.
“Fidelity’s mainstay has been active management, and until this point in time, it has been very difficult to get ETFs around active funds,” said Gus Sauter, who co-invented Vanguard’s patent while serving as its chief investment officer. “I think Fidelity is looking at this as an opportunity to get into the space in a big way.”
A Fidelity spokesperson declined to comment.
The dual-share class structure gives mutual funds access to the tax advantages of ETFs, boosting after-tax returns.
Distinct tax treatments have historically separated the ETF and mutual fund categories, with the former able to avoid capital-gains levies via its unique in-kind redemption process.
Vanguard, by creating ETF classes for some of its traditional products, has used the design — entirely legally — to slash the taxes reported by its funds for more than 20 years.
Fidelity said in its application that portfolio managers who oversee dual-class funds could engage in “careful tax management.”
‘Big Moves’
When U.S. regulators introduced sweeping rule changes in 2019 to make launching ETFs easier, the U.S. Securities and Exchange Commission deliberately retained the need for issuers to apply for an exemption if they wanted to pursue ETFs in a multiple-share class structure.
