The dual share class race is on, and F/m is in pole position.

The long-awaited dual share class structure made its official debut last week when Texas-based F/m Investments announced that its US Treasury 3-Month Bill ETF (TBIL) will offer both ETF and mutual fund share classes. The announcement marks the first time a firm has successfully launched the dual share class structure, an idea that has percolated across the industry since Vanguard’s patent on the model expired in 2023. The move is the first step toward what many in the industry consider the future of portfolio construction, particularly as mutual funds struggle to keep up with ETFs’ popularity. It could also allow strategies in exchange-traded funds to trade in 401(k) accounts, which are currently dominated by mutual funds.

“When’s the last time anyone covered a really cool mutual fund that just launched? Probably 20 years ago,” said Alex Morris, CEO of F/m Investments. “All of the innovation is happening in the ETF space.”

One Portfolio, Two Doors

Dual share classes give investors multiple ways to access the same strategy. In the case of F/m’s flagship product, buyers can now choose between the traditional ETF share class, which trades on an exchange, and a new mutual fund-style option designed for direct purchases. The fund may also now become available to investors in retirement plans. In theory, an advisor can recommend TBIL’s mutual fund equivalent, operating under the ticker TBFMX, in their 401(k) or individual retirement account. “You’ll see us start working with the recordkeepers to bring TBIL to [retirement accounts],” Morris said. “A 401(k) program could ring us up today and make it available to their investors tonight.” Investors can also buy multiple shares of the fund for both their brokerage and retirement accounts.

Although F/m is the first to bring the structure to market, others are lined up to join the party:

• Dimensional Fund Advisors, the first to have its dual share class proposal greenlit by the Securities and Exchange Commission, was widely considered the blueprint for agency approval.
• Other big names in the industry — including BlackRock, Fidelity and State Street — have also filed.

Quick Draw. The reason F/m beat Dimensional to the punch, Morris said, is because the former was giving an ETF a mutual fund share class, while the latter is trying it the other way around. “DFA was very aggressive, and they were ahead of us in the queue for approval, and we all benefited from that,” he said, adding that F/m’s strategy allowed for a methodical rollout and backtesting.

Morris said that once an ETF share class of a mutual fund is launched, there’s nothing stopping massive price fluctuations, whereas F/m is limiting TBFMX’s availability at the start. “DFA’s interest in an ETF share class is like dropping everyone into the boiling cauldron, because once it’s in the ETF format, you can’t stop it.”

Some ETFs have “buff” in their names, but that doesn’t mean they’re strong performers.

Buffer funds have become the largest category within ETFs by number of products, and they are among the fastest growing by assets. By employing options, they offer protection from losses, but that doesn’t necessarily serve most long-term investors well, according to a recent report from Morningstar.

“They definitely fit best with investors that have shorter time horizons,” said Zachary Evens, Morningstar manager research analyst and the report’s lead author. Such investors might be near retirement and concerned about “black swan” events like Covid-19 or the 2008 financial crisis, he noted. “For investors that might not be able to stomach such a decline in the equity markets but have a longer time horizon, it could make sense on the behavioral side of it.”

Results May Vary

Two factors can hold back buffer ETFs. Obviously, the caps on positive returns are a limiter. But the funds’ fees tend to be higher than those of otherwise comparable funds, albeit without the protection against losses, which can be a drag on net returns. The S&P 500 index rarely dropped more than 20% during any 12-month period since 1970, though it went up 20% or more roughly a third of the time, the report noted. Most buffer ETFs would have protected against losses during that timeframe, though the extreme declines would have exceeded most protection limits, and investors would have missed much of the stock market rebounds because of caps.

There is also a wide range of products out there:

• About 420 defined-outcome ETFs were on the market as of the end of last year, representing $78 billion, per Morningstar.
• Many offer protection on 15% of losses, though some go as far as 100% principal protection. They are also available for assets ranging from US equities to bitcoin.
• The two biggest issuers, First Trust and Innovator (which is being acquired by Goldman Sachs), have about $40 billion and $28 billion in defined-outcome ETF assets under management, respectively.

Apples and Oranges? Buffer ETFs have done well for advisors who want to offer risk mitigation and precision to clients, said Matt Kaufman, head of ETFs at Calamos. And they offer a much more liquid alternative to insurance products like registered index-linked annuities, a category that has also been growing for years, he noted. Many investors have been using buffer ETFs for retirement spending, while some institutions have turned to them instead of hedge funds, he said.

“If you view them as a bond-replacement, a risk-management tool, you can make the case that a large part of your portfolio can be allocated to buffered ETFs,” he said. “There’s a large number of Americans, especially retirees, whose goal is to provide for themselves … Their goal is not to maximize the Sharpe ratio.”

Sorry, Kermit. Looks like it might actually be easy to be green.

An index of publicly listed US companies with over half their revenue coming from “sustainable” activities has significantly outperformed the broader market, even more so than companies with heavy ties to fossil fuels. Non-profit shareholder activist As You Sow’s Clean200 list of companies returned a gross total of 283% since it started on July 1, 2016, compared with 221% for the MSCI ACWI and 111% for the MSCI ACWI/Energy Index. “If you had bought into the Clean200 as an idea (in 2016) … you would outperform the ACWI considerably, and you’d outperform fossil fuels ridiculously,” As You Sow CEO Andrew Behar said.

American Exceptionalism

Sustainable funds including ETFs don’t beat the broader market in every environment, said Toby Heaps, cofounder of sustainable research organization Corporate Knights, which contributed to the report. The interest rate cycle is a factor, since cheap financing fuels sustainable projects, but companies in the index have been growing revenues at rates roughly double those of the larger economy, he said. The Trump administration’s pursuit of cheaper oil prices may not significantly change that, in part because electricity (such as for cars) remains affordable and because the US is not the global economy, which is broadly shifting toward sustainable energy, Heaps said.

Still, the holdings in many funds look a lot like those of other funds, sans Big Oil. As You Sow’s index is heavy on industrials, consumer discretionary, materials, information technology, utilities, health care and communications. The funds’ holdings include:

• Amazon, Apple, Microsoft, Tesla and Contemporary Amperex Technology Co.
• Those overlap with many of the top positions in the $15 billion iShares ESG Aware MSCI USA ETF (ESGU), which has returned 13% on average over five years (it returned 17% last year, compared with 22% for the MSCI ACWI).

It’s Bigger: Renewable sources of electricity accounted for more than 90% of the world’s added capacity last year, Heaps noted. And that isn’t just a story about China, which is rapidly expanding cleaner sources of power. Texas, for example, is the top state for wind energy production, and one of the leading solar producers, according to government data. “In the US, even with all this noise … You still see states like Texas that are leading the way, adding thousands of megawatts of solar and wind,” Heaps said.