Perhaps “seminal” is a bridge too far, but a fairly historic event occurred last week in the exchange traded funds (ETFs) industry when Dimensional Fund Advisors (DFA) brought its first ETF share class of an established mutual fund to market.
For advisors and investors that aren’t yet ETF geeks, it’s worth noting that this event, though telegraphed, is historic in ETF industry terms for a simple reason: DFA becomes the first firm since Vanguard to roll out ETF share classes of incumbent index or mutual funds.
The asset manager broke new ground with the March debut of the DFA US Micro Cap ETF (NYSE: DFMC). Both the ETF and the mutual fund attempt to beat the widely followed Russell 2000 Index and for advisors that aren’t familiar with DFMC’s mutual fund parent, it turns 45 years old in December, confirming it’s battle-tested and has staying power.
Regarding DFMC particulars, don’t be deceived by the micro-cap name. Going by the strict definitions of the market capitalization segments, small-cap is $200 million to $2 billion, but the weighted average market value of this ETF’s 1,688 holdings is $3.13 billion, according to issuer data. That implies it’s more of a small mid-cap fund than a micro-cap product. It charges 0.41% per year, or $41 on a $10,000 investment. That’s the same expense ratio found on the mutual fund.
Why the DFA Launch Matters
In short order, DFA has become the largest issuer of actively managed ETFs and the seventh-largest U.S. ETF issuer overall – statuses arrived at prior to the launch of DFMC.
So adding to the issuer’s ETF heft isn’t what makes DFMC relevant. It’s more about how many more DFA mutual funds will get ETF share classes and how many more issuers will attempt to follow suit. Remember, Vanguard’s patent on ETF share classes expired nearly three years ago and plenty of issuers beyond DFA filed for regulatory approval of this scheme. So yes. The floodgates very well could be opening, albeit in incremental fashion.
As for DFA, it filed for a dozen other ETF share classes in addition to DFMC and given that the asset manager is revered for its value approach among larger stocks, among other asset classes, it likely doesn’t small-cap fund to be its lone ETF share class for too long, but that’s just my opinion.
“The remaining 12 funds should receive their ETF share classes soon. Dimensional expects to have a handful of them trading on exchanges by the end of the year,” notes Daniel Sotiroff of Morningstar. “The net expense ratios charged to investors of Dimensional’s ETF share classes are expected to closely match those of the existing mutual fund shares, so investors can choose the most appropriate vehicle without worrying about costs.”
Floodgates Part II
As for how many more ETF share classes come to market in the years ahead beyond those DFA is expected to launch, a precise number is hard to come by at this juncture, but it’s going to be a lot. Including DFA, 98 asset managers have sought regulatory approval for ETF share classes.
That’s not surprising. Those firms know advisors and investors want the low fees and tax benefits associated with ETFs. Speaking of efficiencies, ETF share classes have those in spades, including those of the tax variety.
“ETF share classes can also help mutual fund investors move into ETFs without selling their mutual fund shares and incurring capital gains taxes,” adds Sotiroff. “Dimensional plans to process those transfers manually until an industrywide solution is available later this year. Sorting out the mechanics of these transfers has been one of the bottlenecks to creating ETF share classes.”
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