Vanguard, the world’s second-largest asset manager, has held a patent since 2001 allowing the company to manage an “ETF-as-a-share-class” structure, facilitating greater tax efficiency and economies of scale.
This patent, which protects Vanguard’s innovative model of managing a mutual fund and an associated ETF as essentially the same entity, is expiring in May 2023. Vanguard currently operates 70 multi-share class funds, representing around 60% of its total AUM of $4.8tn.
Challenges Faced By American and European Asset Managers
The expiration of this patent may significantly impact the mutual fund industry in the US and Europe. US-based PGIA, an arm of Australian asset manager Perpetual, has already filed to use the ETF-as-a-share-class structure post-patent expiration. If the SEC approves this application, it could trigger a wave of similar moves by other asset managers, potentially revolutionising the industry.
However, such a transition presents several challenges. The SEC, having expressed concern in 2019 about potential conflicts of interest among investors in a fund’s share classes, may be hesitant to grant similar relief to other asset managers. For instance, the variation in trading costs between mutual funds and ETFs could place varied cost burdens on the portfolio, impacting all shareholders. It remains uncertain whether the SEC will revisit older models, given its evolving stance on ETF structures.
Across the Atlantic, HSBC Asset Management has announced the launch of four passive bond mutual funds in Europe, adopting Vanguard’s ETF-as-a-share-class structure. This move follows a 2018 rule change by the Central Bank of Ireland allowing such structures. However, Europe too faces challenges, including legal stipulations requiring all share classes under the umbrella structure to share the same fund name, leading to mutual funds being labelled as ETFs. European asset managers will need to navigate regulatory approval from bodies like the SEC while managing potential conflicts of interest between share classes.
Despite these challenges, asset managers are keenly watching these developments. Some managers have begun converting mutual funds into ETFs, and there is potential for the launch of mutual funds as a share class by ETF providers.
Conclusion
The decision by the SEC on PGIA’s filing, expected within 120 days of May 2023, could shape the future of the mutual fund industry. If favorable, it could trigger a surge of ETF-as-a-share-class structures. Similarly, the launch of HSBC’s Vanguard-style ETFs in Europe could spark a wave of similar introductions from other asset managers, provided they overcome distribution and naming challenges.
In conclusion, the expiration of Vanguard’s patent heralds a new era for the asset management industry, with significant implications for both US and European markets. As asset managers strive to exploit this opportunity, they must address regulatory challenges and potential conflicts of interest, ensuring the transition benefits all stakeholders within the industry.
