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Monday, November 30, 2009

In Case You Are Under The Illusion That the Mutual Fund Industry Cares About Your Financial Well Being....

the WSJ gives us this convoluted tale of load mutual funds (my italics and bolds)

B Shares Sent to Detention


Mutual-fund firms are giving B shares an F—and kicking them out of school.
More fund companies are dropping B shares, a class of mutual-fund shares that hit investors with a back-end sales charge, known as a "load," once investors sell. The more-numerous A shares levy a load at the time of purchase.

The bear market and its aftermath, the woes of asset-backed securities and regulatory problems have put pressure on the B shares' fees earned by fund houses and the brokers who peddle the B portfolios. "So they are eliminating B shares from their sales platforms," says Eric Jacobson, director of fixed-income research at fund tracker Morningstar Inc. "When things were growing regularly, the whole scheme was fine. Now it is not."....

. The fund industry says B shares are shrinking due to lower customer demand. In fact, the number of B shares offered and the class's sales volume have gone down because the fund companies and brokers no longer want to peddle the Bs. ....

There never was genuine consumer demand for "B" shares. They were simply a marketing gimmick:

A shares, with their up-front loads, were the norm years ago, until the advent of no-load funds from the likes of the Vanguard Group and T. Rowe Price sent load houses scrambling for a product to competee. In the late 1980s, they came up with B shares, which sales reps touted as a cheaper way to own funds than A shares.

If you think many investors understood this(below) or brokers clearly explained them (yes the info was eventually buried in the prospectus) I can assure you that you are sorely mistaken. I worked a few months (i wouldn't sell this stuff which made me very unpopular) at a firm they peddled only load funds I can assure you that few of the salespeople could calculate the costs of investing over time in the different share classes. But they definitely knew what the payout (commission) was.

The differences among share classes are complex (now there's an understatement) Typically, with A shares, investors are charged a 5.75% up-front load, whose proceeds are split between the broker and the fund company. On top of that, the investors might pay 1.20% of assets in yearly fees to the fund house.
B shares have a lower load, often around 4%, but impose a higher yearly fee, usually on the order of 1.9%. Investors in B shares have to pay the load if they sell the fund. That 4% load, however, shrinks to zero over time, usually six or seven years. Then the B shares morph into A shares, and investors pay the As' lower yearly fees. (For the most part, fund families that are dropping their B shares will let keep existing B holders in place, since they will eventually be phased out.)
A third class, C shares, has a smaller load that often goes away sooner, perhaps in a year, but they don't convert to A shares and investors must keep paying fees as high as those of B shares in perpetuity.

And here is where the marketing sleight of hand comes in: when the good guys with no loads and low management fees came into the game some informed investors complained to their brokers about paying hefty front end loads (commissions) to buy mutual funds. So the marketing whizzes came up with the B shares: no front end load but higher annual management fees (so the investor doesn't see it clearly) and a gradually declining back end fee upon selling the fund (effectively locking the client into the fund company (a stable stream of asset management fees for the fund company) or hitting him with more fees if he wants to sell withing a period lasting 5 yrs and sometimes longer. A classic use of behavioral finance: bury the explicit costs and convince the investor it is very close to a no load mutual fund.

And here comes the real reason for the decline in "B" shares. It's all about broker payout and little if anything about consumer preferences. If the conditions described here would have never materialized the brokers would still be flogging those b shares,

Brokers, however, don't want to wait around in hopes of collecting a back-end load from B shares some day. When B shares are sold, fund houses take no cut and pay brokers the entire 4% load as an incentive. In lieu of a slice of the 4% load, the companies charge the higher yearly fees. Until a year ago, the fund firms could finance that 4% outlay to the brokers by securitizing the Bs' 1.9% yearly fee income.
Trouble is, asset-backed securities were decimated in the bear market and haven't recovered yet. With securitizing scarce, that means the fund houses, out of their own pockets, must underwrite the brokers' 4%.
Worse, both brokers and fund houses collect less these days from Bs' loads and fees because fund values, while improved since last March's market low, are nowhere near the levels earlier in the decade. A 4% load and a 1.9% yearly fee bring in less today, when B shares' assets total $113 billion, than they did in 2007, when B assets were $234 billion.
B shares first ran into trouble, and inspired industry unease, when regulators began looking into whether brokers were pushing the Bs even though another type of investment was more suitable.

(what a shocking surprise)

In 2005, to mollify the regulators, many fund firms put ceilings of $50,000 or less per customer on the amount of B shares that could be sold.
The fund houses that are backing out of B shares are mostly tight-lipped about why they are getting out.
"Demand for the share class has declined dramatically," thus fund houses no longer are enamored of them, says Chris Doyle, a spokesman for American Century Investments.

the above quote may be true but only it is demand from the commissioned brokers, not investors that Mr. Doyle is speaking about.

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