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Dimensional Takes Aim at Vanguard’s Hybrid Mutual Fund-ETF Structure

Dimensional lays out its case for adding an ETF share class to its mutual funds.

On Thursday, July 13, 2023, Dimensional Fund Advisors took another big step to advance its presence in the exchange-traded fund market. The firm filed a request with the SEC that, if approved, would allow its existing mutual funds to offer an ETF share class. The hybrid mutual fund-ETF structure is currently used exclusively by many of Vanguard’s index-tracking mutual funds. The Malvern, Pennsylvania, based firm had a patent on this unique fund structure that expired in May. Dimensional’s filing is the second of its kind in 2023. PGIA made a similar filing on Feb. 7 in anticipation of Vanguard’s patent expiring.

Overall, the addition of ETF share classes should largely benefit Dimensional’s mutual fund clients. The hybrid structure would allow existing clients access to the ETF’s tax efficiency. They wouldn’t have to sell their mutual fund shares to purchase a stake in the equivalent ETF share class, which could trigger capital gains distributions and taxes. Instead, bolting on an ETF share class gives them the tax advantages of the ETF’s redemption mechanism that can reduce, if not eliminate, capital gains distributions.

Many of the firm’s mutual funds are a great fit for the hybrid structure. Like many Vanguard clients, most of Dimensional’s investors stay put for years, if not longer. A mass exodus from the mutual fund, which could compromise the tax benefits of the bolt-on ETF, is unlikely. And a number of Dimensional’s funds are among the most diversified strategies in their given categories, so the odds are small that they’ll need to close these funds to help manage capacity.

In an interview with Morningstar, Dimensional’s co-CEO and CIO, Gerard O’Reilly, confirmed that the filing applies to all the firm’s U.S. mutual funds. If the SEC approves, its mutual fund board would ultimately determine which funds get the ETF share class and when.

Dimensional has not been bashful about moving into ETFs over the past three years. It began launching stand-alone ETF versions of its mutual funds in November 2020. The firm followed that by converting seven tax-managed mutual funds to ETFs between June 2021 and May 2022.

So far, Dimensional’s foray into the ETF world has been the most successful effort among actively managed mutual fund providers. The firm launched a total of 31 ETFs over the past three years, with more slated to start trading later this year. Those ETFs had more than $93 billion in assets under management at the end of June. More than $47 billion of that sum was new money that entered since they hit the market in late 2020 (excluding the money that came in from its seven mutual fund conversions).

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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Daniel Sotiroff

Senior Analyst
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Daniel Sotiroff is a senior manager research analyst for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He covers passive strategies.

Before joining Morningstar in 2017, Sotiroff was as a design engineer at Caterpillar, where he worked on front-end loaders for heavy construction and mining applications.

Sotiroff holds a bachelor's degree in mechanical engineering and a master's degree in applied mechanics, both from Northern Illinois University.

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