Dual-Class ETFs, Mutual Funds Could Reshape 401(k) Landscape

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In the 2000s, when ETFs started to explode in the retail market, a couple of high-flying firms like iShares and Nasdaq announced their intent to enter the 401(k) market with great fanfare and compelling arguments. Though there are and were great advantages to ETFs over mutual funds, like price, efficiency and transparency, due to record-keeper operational challenges, ETFs never took off beyond being building blocks within professionally managed investments like target-date funds.

CITs have become the darling of the DC market, largely due to lower costs, especially in the advisor-sold market, where an advisory group can pool its assets and offer them to even the smallest clients. They now have more assets in TDFs than mutual funds and are growing faster in the DC market.

But a recent SEC ruling earlier this year allowing dual-class ETFs and mutual funds could change that, according to State Street Investment Management’s head of DC product strategy, James Veneruso. While most firms are focused on creating an ETF version of a mutual funds, Veneruso claims that a mutual fund share class of an ETF could eliminate operational challenges that kept ETFs out of 401(k) plans over 20 years ago.

The SEC ruling allows investment companies to offer the mutual fund version of an ETF, leveraging their scale, cost discipline and efficiencies while taking advantage of innovations such as blending public and private investments and retirement income, potentially eliminating transferability issues. Lincoln Financial launched the first-ever fixed annuity ETF late last year.

The SEC dual class share ruling allows investment firms to access a single pool of assets through both a mutual fund and an ETF. There are 4,300 ETFs with over 1,900 launched in the last three years, with inflows of $2.4 trillion in 2025 compared to $700 billion of mutual fund outflows.

CIT’s lower costs have greatly benefited 401(k) plans and participants, but there are serious issues. Operation inefficiencies were highlighted by the ICI recently, comparing the current system to the pre-NSCC days for mutual funds, which made trading cumbersome. Today, each CIT provider has their own adoption agreements and rules with no cooperation. Not all CITs have ticker symbols, and many experts claim that oversight by the SEC offers greater investor protection than the OCC, which regulates CITs.

Most DC plans require an investment to have a three-year history with CITs adopting the performance of their mutual fund clone. But there can be differences in performance and holdings, especially with cash reserves and the time an investment has been held. Though legislation is pending to allow 403(b) plans to use CITs with bi-partisan support, getting any legislation passed these days is nearly impossible.

Further, CITs can cause conflicts of interest and confusion.

Unlike mutual funds, every firm can offer its own CIT for the same investment strategy at a different price, causing plan sponsor confusion. Advisory firms that create CITs have an incentive to push these investment strategies to create a competitive advantage at the expense of recommending more appropriate investments. And the largest CIT provider in the advisor-sold market is charging investment firms seven-figure distribution fees, which, while not a violation, will have to be paid by someone and will eliminate worthy investment companies that cannot afford or are unwilling to pay the toll. They also control one of the most popular investment analytic tools, which could affect their neutrality.

ETF versions of mutual funds are cleaner, cost-efficient and more transparent than CITs without apparent conflicts and are overseen by the SEC, offering greater investor protection. As firms like State Street offer these dual class ETFs to 401(k) plans, advisors that adopt them will have a clear competitive advantage, leveraging a much larger pool of assets and strategies than CITs while growing faster.

Finally, CITs are limited to institutional investors. With $1 trillion rolling out of DC plans into IRAs where CITs are not allowed, investors using CITs in their 401(k) plan will be forced to switch to a potentially higher-priced fund if they want to use the same investment strategy, unlike ETFs.