For the past decade, exchange-traded funds (ETFs) have been eating actively managed mutual funds' lunch.
This feasting is partly an extension of investors' shifting preference for ultra-low-cost index funds. However, the reported tax efficiency of ETFs has also boosted their popularity. It may be just as accurate to say that investors are tired of mutual funds kicking out big capital gains year after year.
Investment companies focused on actively managed funds can't do much about the shift in investor preferences—except maybe by performing better! However, the tax issue could be solved if only there were a way to bring the tax efficiency of ETFs to mutual funds.
While many of Vanguard's competitors, such as Fidelity, T. Rowe Price, Capital Group (the American funds) and DFA, have been either rolling out actively managed ETFs or converting their existing mutual funds into ETFs, Vanguard has for the most part sat on the sidelines.
Yes. Vanguard has a handful of actively managed ETFs—the five factor ETFs and three bond ETFs—but I'm thinking of Vanguard's traditional stock-picker funds like Dividend Growth (VDIGX) or Windsor (VWNDX). For instance, Fidelity launched an ETF version (FMAG) of its actively managed Magellan mutual fund (FMAGX) in February 2021.
Vanguard's lack of active ETFs is a bit surprising given that it appears to have "the solution" in hand: Open up ETF share classes of its existing active funds. After all, this worked for the fund giant's original index funds.
But it's not that easy.
So, let's start by viewing Vanguard's actively managed ETFs from 30,000 feet. Then, I'll drill down and compare them against their mutual fund siblings.
Where Are Vanguard's Active ETFs?
In 2000, the SEC gave Vanguard permission (exemptive relief) to create ETF share classes of its open-end index mutual funds. Thanks to their unique dual share class structure, Vanguard's index mutual funds have the same tax benefits as any ETF, as I showed you here.
However, I've been very careful to talk about Vanguard's index mutual funds because the SEC's exemptive relief did not apply to Vanguard's active mutual funds. In fact, the SEC denied Vanguard's 2015 request that the relief be expanded to cover its active funds.
The SEC is concerned that the dual share class structure results in one set of investors subsidizing another. So far, the SEC has not approved any applicants looking to copy Vanguard's approach. This suggests that the SEC may regret granting Vanguard exemptive relief in the first place!
Aside from the SEC's denial, there could be other reasons Vanguard hasn't entered the active ETF waters.