The SEC's Dual-Share-Class Approval: A Game Changer for Active Fund Managers and Tax-Efficient Investing

The U.S. Securities and Exchange Commission's (SEC) September 2025 approval of dual-share-class structures for registered funds marks a pivotal moment in the evolution of the investment industry. By granting Dimensional Fund Advisors LP (DFA) exemptive relief to offer both exchange-traded fund (ETF) and mutual fund share classes within the same portfolio, the SEC has dismantled a long-standing regulatory barrier, opening the door for broader adoption of this hybrid model according to Morgan Lewis. This development is not merely a technical adjustment but a strategic repositioning opportunity for active fund managers, enabling them to address investor demand for flexibility, tax efficiency, and competitive differentiation in an increasingly fragmented market as reported by Bates White.

Strategic Fund Structure Innovation: Breaking Monopolies and Expanding Distribution

For decades, the ability to offer dual-share-class structures was effectively monopolized by Vanguard, which held a patent on the model until 2023 according to TCW. The expiration of this patent, coupled with the SEC's recent approval of DFA's application, has catalyzed a wave of innovation. Over 80 asset managers have since filed for similar relief, signaling a structural shift in how firms approach product design and distribution according to Plan Adviser. This proliferation of dual-share-class funds allows active managers to cater to distinct investor preferences-offering ETFs for liquidity and tax advantages while retaining traditional mutual fund structures for institutional or retail clients who prefer daily net asset value (NAV) pricing according to AI-CIO.

The strategic implications are profound. By diversifying their share classes, asset managers can expand their reach into new investor segments, including those who prioritize tax efficiency in taxable accounts or seek the flexibility of intraday trading. For example, DFA has already begun attaching ETF share classes to 13 of its mutual fund portfolios, spanning large-cap, small-cap, and mid-cap strategies according to AI-CIO. This approach not only enhances product accessibility but also positions firms to compete more effectively with passive strategies, which have historically dominated the ETF space.

Tax Efficiency: A Competitive Edge for Active Managers

One of the most compelling arguments for dual-share-class structures is their potential to enhance tax efficiency-a critical differentiator for active fund managers. Traditional mutual funds often distribute capital gains to shareholders when portfolio securities are sold, whereas ETFs utilize in-kind redemption processes to transfer securities without triggering taxable events as noted by Wealth Management. This mechanism allows investors in dual-share-class funds to switch between ETF and mutual fund share classes without incurring capital gains, a feature particularly valuable for taxable accounts according to Wealth Management.

According to a report by JPMorgan, this tax advantage could help active managers retain assets that might otherwise flow to passive strategies, especially as investor demand for tax-optimized solutions grows according to JPMorgan. For instance, Dimensional's dual-share-class model is expected to reduce or eliminate capital gains distributions for investors, aligning with broader industry trends toward minimizing tax drag according to Dimensional. However, the SEC has emphasized the need for rigorous governance to ensure equitable treatment across share classes, including transparency in expense allocation and cross-subsidization according to BBH.

Challenges and Operational Complexities

While the benefits are clear, the adoption of dual-share-class structures is not without challenges. Implementing these models requires robust infrastructure, including coordination with custodians, market makers, and distribution platforms to manage liquidity and pricing discrepancies according to Investment News. Additionally, firms must navigate administrative complexities, such as managing cash drag in mutual fund components and ensuring compliance with SEC guidelines on cross-subsidization according to JPMorgan.

For example, the transition for existing mutual fund investors to ETF share classes may involve logistical hurdles, including communication strategies and investor education according to KLGates. Moreover, the operational costs of maintaining dual share classes-such as increased reporting requirements and governance oversight-could offset some of the economies of scale anticipated by asset managers according to JPMorgan. Despite these challenges, industry experts argue that the long-term benefits of expanded distribution channels and investor flexibility outweigh the short-term costs according to BBH.

Market Implications: A New Era for Active ETFs

The SEC's approval is also expected to accelerate the growth of active ETFs, which have already captured a significant share of ETF flows and launches according to TCW. By enabling active managers to offer dual-share-class structures, the regulatory shift addresses a key limitation of traditional active strategies: the lack of liquidity and tax efficiency associated with mutual funds. This development could help active managers compete more effectively with passive ETFs, particularly in strategies where active management adds value, such as small-cap equities or fixed-income markets according to Bates White.

Furthermore, the dual-share-class model may reshape the competitive landscape for financial advisors and distributors. As noted by Bates White, distributors must adapt their compensation models and sales strategies to accommodate these new offerings, which could introduce new revenue streams while requiring careful alignment with investor needs according to Bates White.

Conclusion

The SEC's dual-share-class approval represents a transformative shift in the registered funds marketplace, offering active fund managers a powerful tool to innovate, differentiate, and meet evolving investor demands. By combining the flexibility of ETFs with the familiarity of mutual funds, this model addresses critical pain points in tax efficiency and liquidity while expanding distribution opportunities. However, successful implementation will depend on firms' ability to navigate operational complexities and maintain transparency in governance. As the industry moves forward, the dual-share-class structure is poised to redefine the competitive dynamics of active investing, positioning it as a viable alternative to passive strategies in an increasingly sophisticated market.