Vanguard’s Tax-Busting Fund Design Is Getting Its Latest Revamp

Vanguard Group has famously stood apart in the money-management world with its popular mutual funds offering the liquid ETF wrapper.

(Bloomberg) — Vanguard Group has famously stood apart in the money-management world with its popular mutual funds offering the liquid ETF wrapper.

Now, F/m Investments is bidding to create essentially the opposite: Exchange-traded funds that tack on a mutual fund as a share class.

The Washington, DC-based firm is seeking permission to create mutual funds as a share class of its ETFs, according to a Tuesday filing with the Securities and Exchange Commission. The structure would allow for the burgeoning ETF issuer to tap into parts of the investment world that are typically reserved for just mutual funds, like retirement accounts.

F/m’s move comes after two asset managers filed to mimic Vanguard and create an ETF share class of their existing mutual funds, in a bid to port the famous tax efficiency of an ETF into the mutual fund. Vanguard held a patent on that specific design for over 20 years, but it expired this May. 

Distinct tax treatments have historically separated the ETF and mutual fund categories, with the former able to avoid capital-gains levies via its unique in-kind redemption process. Vanguard, by creating ETF classes for some of its traditional products, has used the design — entirely legally — to slash the taxes reported by its funds for more than 20 years.

F/m Investments appears to be taking several tips from Vanguard’s playbook. In addition to applying with the SEC for permission to implement the fund design, the firm is also applying for a patent on their fund structure. 

Whether or not F/m Investments can offer the structure rests with the SEC, which has indicated questions relating to conflicts of interest among share classes. In sweeping rule changes introduced in 2019 to make launching ETFs easier, the SEC deliberately retained the need for issuers to apply for an exemption if they wanted to pursue ETFs in a multiple share class structure.

The SEC did not immediately respond to a request for comment. 

F/m’s ETFs track individual Treasury securities. Their most successful product — TBIL — tracks the US 3-month Treasury bill and has amassed $1.6 billion since launching roughly one year ago.

Alexander Morris, F/m’s president and CIO, says that given the highly liquid nature of the holdings of these ETFs, this could mitigate concerns that the US regulator has had about this structure. 

“F/m likely believes the benefit of being able to use the tax efficiency for the already successful ETFs and share that tax efficiency with potential mutual fund holders is probably worth the effort here,” said James Seyffart, ETF analyst at Bloomberg Intelligence. 

–With assistance from Sam Potter.

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