SEC Clears the Way for ETF Share Classes on Mutual Funds, a Tax-Efficiency Shift

On September 29, 2025 the Securities and Exchange Commission issued a notice of its intent to grant Dimensional Fund Advisors an exemptive order allowing the firm to offer an exchange-traded fund share class alongside the mutual fund share classes of the same portfolio. The relief, the first of its kind the SEC has signaled since 2007, opens a structure long associated with lower taxable capital-gain distributions to a much wider set of fund families, with roughly 70 other asset managers waiting on similar applications.

What changed

An ETF share class lets a single pooled portfolio issue two kinds of shares: the traditional mutual fund shares bought and sold at end-of-day net asset value, and ETF shares that trade all day on an exchange. The mechanism that makes this tax-relevant is the ETF's in-kind creation and redemption process, which lets the fund hand out appreciated securities to large institutional intermediaries instead of selling them for cash, avoiding a taxable event inside the fund. Until now, only Vanguard could offer this structure at scale because it held a patent on the approach that expired in 2023. Dimensional's exemptive application, first filed years earlier, combines standard ETF operating relief under Rule 6c-11 with additional relief needed to run ETF and mutual fund share classes inside one fund under Rule 18f-3.

Who is affected

Investors holding actively or passively managed mutual funds in taxable brokerage accounts are the ones most likely to benefit, since retirement accounts like 401(k)s and IRAs are already shielded from annual capital-gain distributions by their tax deferral. High earners who hold substantial taxable, non-retirement portfolios, and who have often gravitated toward ETFs specifically to avoid year-end capital-gain surprises, stand to gain the most as more of their existing mutual fund managers add ETF share classes to funds they already own, rather than forcing a fund switch. Fund sponsors benefit too: adding an ETF share class can let a firm retain assets that might otherwise migrate to a competitor's ETF lineup.

The after-tax math

Example: an investor holds $500,000 in a taxable actively managed mutual fund that distributes capital gains equal to 8% of net asset value in a strong year, a level that has occurred in real funds during periods of heavy redemptions or portfolio turnover. That is a $40,000 taxable distribution, and at a 23.8% combined federal long-term capital gains and net investment income tax rate, the resulting bill is about $9,520, due even if the investor never sold a share and the fund's price barely moved. An ETF share class of the same strategy, using in-kind redemptions to manage outflows, would typically distribute little or no capital gain in the same scenario, though it does not eliminate the eventual tax due when the investor sells; it defers that tax and can let it convert to a lower future capital-gains rate depending on the investor's circumstances at the time of sale.

What to watch

The Dimensional order is a notice of intent, not a final grant; the SEC typically finalizes such orders in the following weeks absent a hearing request, and the roughly 70 other pending applications, from large fund complexes across the industry, are expected to move through a similar process once the first order is final. Not every existing mutual fund will get an ETF share class quickly, since firms must amend registration statements, secure board approval and coordinate with exchanges and market makers before shares can list. Investors should also note this structure does not change a fund's underlying strategy or performance, only its tax mechanics, and any decision to move from mutual fund shares into a new ETF share class of the same fund is worth discussing with a CPA or financial advisor to confirm it can be done without triggering an unwanted taxable exchange.

Why the structure took 18 years to reach other fund families

Vanguard obtained its original SEC exemption to run an ETF as a share class of its index mutual funds in 2000, then patented the structure in 2003, giving it more than two decades most competitors could not replicate. The patent expired on May 16, 2023, and Dimensional was among the roughly 70 asset managers, including BlackRock and State Street, that filed new applications seeking the same relief once the patent lapsed. The SEC had granted a handful of similar exemptive orders around 2000 but had not advanced a new application in the years since, so the September notice represents the broadest reopening of the pathway since the patent era began. Because each applicant must show its own fund structure meets the same investor-protection standards, approvals are expected to arrive in a wave over the following months rather than all at once, and the order can still be modified or delayed if the SEC receives a hearing request during the notice period.

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