Vanguard Group’s best-of-both-worlds stranglehold over the money-management industry is facing a new kind of challenger.
This week Washington, DC-based F/m Investments filed to create mutual funds as a share class of its ETFs, in a bold bid to mirror the tax-saving hybrid investing vehicles pioneered by Jack Bogle’s firm more than two decades ago.
In the process, the investment boutique has opened up a new front in the quest among issuers to secure Securities and Exchange Commission approval to replicate a unique fund structure that helped Vanguard become the industry’s second-biggest manager after BlackRock Inc.
At stake: the ability to tap into the multitrillion-dollar industry of mutual funds, all while retaining the tax efficiency of ETFs.
While Vanguard uses ETFs as a share class for many of its mutual funds, F/m Investments is essentially seeking to do the reverse with a first-of-its-kind structure that would establish mutual funds under the ETF banner.
The bid, laid out in a Tuesday filing, comes after at least two issuers also applied this year to recreate Vanguard’s model — the patent for which expired in May.
And F/m has bold ambitions: Just like Vanguard, the firm has also applied for a patent that would help it control who could use its fund design.
“Vanguard had this advantage for the last 20 years — it literally shifted where investment dollars went and the benefits of washing out capital gains, and no one could really use it without paying a licensing fee,” said Todd Sohn, ETF Strategist at Strategas. “Now we have a reverse effect in play where another firm is trying to do the same thing.”
F/m’s ETFs invest in Treasury securities. Its most successful product — TBIL — tracks the three-month Treasury bill and has amassed $1.6 billion since launching roughly one year ago.
To create its proposed new structure, the issuer needs a special exemption from existing rules from the SEC. But since approving the original dual-class funds for Vanguard index products two decades ago, the regulator has developed concerns that could also apply to the reverse model.
The biggest worry: Since cash flows into ETFs and mutual funds in different ways — assets are typically swapped in and out of an ETF via an “in-kind” transaction using an intermediary — the regulator fears that costs will differ between the classes of investors, leading one to subsidize the other.
It’s a hurdle that may prevent any exemption being given to Vanguard copycats, or to F/m.
Given the novelty of the application — F/m’s 10 funds are also the only ETFs that track single Treasury securities — it’s unclear how the current SEC administration will respond, according to Dave Nadig, financial futurist at the data provider VettaFi.
“The SEC is very unpredictable in terms of what they choose to care about,” said Nadig. The ETF market “can apparently do leveraged ether futures, but we can’t do spot Bitcoin,” he said.
The SEC declined to comment.
F/m said it is confident it has addressed the concerns the regulator has expressed. Their lineup of Treasury funds tracks the most liquid market in the world, so the brokerage costs associated with buying and selling US Treasury securities in response to mutual fund share-class flows will be “nominal,” the firm said in a statement.
The money manager’s strategies, which involve holding one on-the-run Treasury security in each fund, provide “greater flexibility and efficiencies with respect to portfolio tax management,” and that mitigates concerns related to distributable capital gains associated with portfolio transactions, it said.
The filing comes after quant giant Dimensional Fund Advisors and Australian-based Perpetual Ltd. filed to mimic Vanguard and create an ETF share class of their existing mutual funds. Those applications are still awaiting responses from the US regulator.
If granted approval, the hope from F/m would be to gain access to parts of the investment world that haven’t typically had the technical infrastructure to cater to ETFs, like the $6.6 trillion 401(k) market.
“Anytime you’re asking for something new, you can’t be terribly confident that it will be granted. I think we present a novel argument to the SEC,” said Alexander Morris, F/m’s president and CIO. “Certainly, no one has done a fund like we have, and has as broad as flexibility as we have.”
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