How Issuers Are Solving the Dual Share Class Puzzle

Dual share classes are officially invited to the party, but they might be a tad late.

Sure, the Securities and Exchange Commission greenlit dual share class applications late last year, but the industry is now facing a major obstacle: A lack of back-office capabilities, or the operational legwork behind actually offering an ETF share class of a mutual fund. Transferring clients’ mutual fund shares to an ETF share class, and being able to do so quickly and tax-free, is much easier said than done, said Dan Sotiroff, associate director at Morningstar. Issuers are wrestling with how to speed up the conversion process, and whether it even makes sense for their clients.

“[Issuers are] still waiting on what has been termed this industry-wide standard … where everybody will be operating on the same protocol,” he said. “It’s just kind of clunky right now.”

Easier Said Than Dual

One reason behind the clunkiness has to do with the different parties involved in transferring shares. The mutual fund’s asset manager has to freeze the investor’s shares and make the exchange with the relevant custodian before sending it back to the broker, who actually puts the shares in the investor’s account. That whole process can take up to two to three weeks in some cases, Sotiroff said. And because most asset managers don’t have the necessary in-house brokerage platform, they have no choice but to go through that process.

“Your shares are still appreciating in value, so you’re not missing out on anything,” Sotiroff said. “But if you wanted to sell, your shares could potentially be locked up for days, if not weeks.”

I’ll (12)B Darned: Also at stake for issuers is whether to make the dual share class available in the first place, said Evan Skalski, senior partner at Alpha FMC. Some providers have 12b-1 agreements in place for their mutual funds, under which the funds can charge marketing and distribution fees. For these providers, it might not make sense to offer an ETF share class if it means losing out on that relationship with a distribution partner.

“Do [issuers] end up losing AUM on their platform if more folks want to move into the ETF share class?” Skalski asked, adding that they now need to decide what happens to assets that migrate out of those mutual funds. “It is a decision for key buyers and heads of distribution at some of the large wirehouses and broker-dealers.”