The Duel Over Dual Share Classes

Dozens of asset managers await the SEC’s approval of dual share classes, but there’s a major obstacle to the success of ETFs they plan to launch: Broker-dealers.

It all comes down to compensation. Unlike retail mutual fund share classes, ETFs do not include sales charges and 12b-1 and sub-transfer agency fees that support brokers’ business models. Not surprisingly, asset managers report having a hard time getting their ETFs approved by broker-dealers. And absent any incentives and revenue-sharing agreements that could make ETFs less financially advantageous for investors, that will probably continue. Thus, the watershed approval of dual share classes expected soon by the Securities and Exchange Commission may not lead to the widespread adoption of ETFs that asset managers are hoping for, a report this week by Cerulli Associates suggests. An industrywide move toward the ETF share class threatens $15 billion to $30 billion in annual revenue for broker-dealers, according to that firm. 

“If they have the expectation of revenue-sharing in an ETF share class, how do they then justify not seeking that on traditional ETFs? That would be so painful,” one executive at an asset manager told Cerulli.

Gotta Pay to Play

While it’s well known that asset managers pay revenue-sharing fees, the extent is not clearly disclosed by broker-dealers. For asset managers, it’s a necessity to ensure their products get shelf space. But a couple of powerful trends pose a threat to brokers’ business models, including the rising demand for ETFs and a shift in financial advice to fee-based compensation. “There is a long-term shift that is taking place here,” said Daniil Shapiro, director of product development at Cerulli and one of the authors of the recent report. Even so, “these [ETF share class] products are going to be hampered in the short term. It’s going to be very difficult for them to get distribution through intermediaries.”

Data from surveys of ETF-issuers by the firm support that assessment:

• 97% said broker-dealers are reluctant to approve ETFs for their platforms, with 54% calling it a significant challenge.
• 89% said supporting mutual fund and ETF share classes entails operational complexity.
• Allowing mutual fund investors to switch to ETF share classes when those become available “is an operational nightmare” that “nobody seems ready to manage,” one asset management executive told Cerulli.

Make It Rain: The firms queued up for dual share-class approval are mostly larger asset managers. And those companies may have to be selective about which strategies they consider for dual share classes. While the industry anticipated approval by the SEC in 2026, the commission’s focus on moving on dual share classes sooner is leaving some firms scrambling, Shapiro said. “We expect a slow rollout of these types of exposures,” he said. “It seems like a lot of market participants were caught off guard.”