The Future Of Mutual Funds
The financial services landscape is an ever-changing environment. Mutual fund share classes are a case in point. Mutual funds are sold in a variety of share classes, with A-shares, B-shares and C-shares being the primary varieties. Ongoing developments in the industry suggest that B shares and C shares may not be around five years from now. In fact, as exchange-traded funds (ETFs) become more popular with investors, the evolution away from B-shares has been realized. (For an introduction to mutual funds, please read Mutual Funds: What Are They?)
Goodbye to Bs
B-shares were once considered a hot commodity for the financial services industry. Financial advisors liked them because they generally have higher management expense ratios (MER) compared to other funds within the same family, making them more profitable to sell. Investors liked them because, unlike A-shares, they were not subject to an initial front end-load. Fast forward to 2008 and the Financial Industry Regulatory Authority (FINRA) issued an investor alert titled "Class B Mutual Fund Shares: Do They Make the Grade?"
In its own words, FINRA issued the alert "because we are concerned that some investors may purchase Class B mutual fund shares when it would have been more cost effective for those investors to purchase a different class of shares." The alert was merely another manifestation of the long-running concern about mutual fund pricing practices. Many investors would become enticed with no up-front costs, only to realize excessive charges once they tried to cash out. Furthermore, B shares provide the advantage of using your entire investment to gain market exposure rather than paying towards upfront fees. Nonetheless, the back-end load fees were judged to be excessive, given the advantages.
The phase of B-shares seems to be the next likely development. Sales of B-shares have been in decline and represented just 1% of the industry's assets at the close of 2009, down from 7% in 2000. Mutual fund firms are getting out of the business, with big names firms including Goldman Sachs, PIMCO, American Century and many other financial institutions dropping B-shares from their product lineups. The fund complexes noted that B-shares are no longer profitable, as the fund companies pay 4% upfront to brokers for selling Bs, and make their cut on the back end by selling asset-backed securities. The collapse of the asset-backed securities market turned B-shares into a significantly less valuable product from a seller's point of view. Pressure on the fund industry to reduce fees in light of poor performance, competition from low-cost ETFs, and pressure from FINRA add fuel to the fire.
Writing on the Wall for C-Shares?
The future of C-shares may also be questionable, as they usually have a higher management expense ratio than other mutual funds in the same fund family. This is notable because in 2009, legislators proposed theInvestor Protection Act. The Act sought to "authorize theSEC to adopt rules under the Exchange Act and the Advisers Act to provide that, when broker-dealers and investment advisers render investment advice about securities to retail customers or clients (and such other customers or clients as the SEC designates by rule), they are required to act solely in the interest of the customer or client without regard to the financial or other interest of the broker, dealer or investment adviser providing the advice." Should all financial services professional be required to act in the best interests of the clients, it would be difficult to justify selling clients expensive C-shares when less expensive shares of the same fund are available.
Unless Wall Street suddenly becomes a benevolent environment where massive profits are passed up in the interests of doing the right thing for investors who have their life's savings at risk, the future is likely to see more attempts at legislative reform. Poor investment performance and pressure to lower prices will also work against efforts to sell expensive products when less expensive alternatives are available. Typically, Class C shares have higher annual and back-end fees than similarly structured A shares. Therefore large scale sales of Class B and C shares are being investigated due to the brokers' neglect for the clients' best interest.
Give me an "A" or Maybe an "ETF"
A-shares are the least expensive of the traditional mutual fund share classes. They are also the least complicated. There are no back-end loads and no graduated pricing structures that reduce the cost to investors based on how long the investment is held. In addition to A-shares, ETFs offer another low-cost investment alternative that are fiercely competing with mutual funds. (If you're an investor who likes to understand how and why your investment products work, An Inside Look At ETF Construction provides a close-up look at the popular, inexpensive portfolios, and Active Vs. Passive ETF Investing explains how you can use these securities for more than just indexing.)
The Bottom Line
The development of ETFs and the rise and fall of B-shares highlights the dynamic nature of the financial services industry. New products are developed and old products are enhanced or eliminated backed on a mix of market-moving forces, including supply and demand, the regulatory environment, and the performance of the products and the financial markets in general. Understanding the products is an important part of becoming a savvy investor.
For more information about how the various types of shares differ and the pros and cons of each, read The ABCs Of Mutual Fund Classes.
Goodbye to Bs
B-shares were once considered a hot commodity for the financial services industry. Financial advisors liked them because they generally have higher management expense ratios (MER) compared to other funds within the same family, making them more profitable to sell. Investors liked them because, unlike A-shares, they were not subject to an initial front end-load. Fast forward to 2008 and the Financial Industry Regulatory Authority (FINRA) issued an investor alert titled "Class B Mutual Fund Shares: Do They Make the Grade?"
In its own words, FINRA issued the alert "because we are concerned that some investors may purchase Class B mutual fund shares when it would have been more cost effective for those investors to purchase a different class of shares." The alert was merely another manifestation of the long-running concern about mutual fund pricing practices. Many investors would become enticed with no up-front costs, only to realize excessive charges once they tried to cash out. Furthermore, B shares provide the advantage of using your entire investment to gain market exposure rather than paying towards upfront fees. Nonetheless, the back-end load fees were judged to be excessive, given the advantages.
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The future of C-shares may also be questionable, as they usually have a higher management expense ratio than other mutual funds in the same fund family. This is notable because in 2009, legislators proposed theInvestor Protection Act. The Act sought to "authorize the
Unless Wall Street suddenly becomes a benevolent environment where massive profits are passed up in the interests of doing the right thing for investors who have their life's savings at risk, the future is likely to see more attempts at legislative reform. Poor investment performance and pressure to lower prices will also work against efforts to sell expensive products when less expensive alternatives are available. Typically, Class C shares have higher annual and back-end fees than similarly structured A shares. Therefore large scale sales of Class B and C shares are being investigated due to the brokers' neglect for the clients' best interest.
Give me an "A" or Maybe an "ETF"
A-shares are the least expensive of the traditional mutual fund share classes. They are also the least complicated. There are no back-end loads and no graduated pricing structures that reduce the cost to investors based on how long the investment is held. In addition to A-shares, ETFs offer another low-cost investment alternative that are fiercely competing with mutual funds. (If you're an investor who likes to understand how and why your investment products work, An Inside Look At ETF Construction provides a close-up look at the popular, inexpensive portfolios, and Active Vs. Passive ETF Investing explains how you can use these securities for more than just indexing.)
The Bottom Line
The development of ETFs and the rise and fall of B-shares highlights the dynamic nature of the financial services industry. New products are developed and old products are enhanced or eliminated backed on a mix of market-moving forces, including supply and demand, the regulatory environment, and the performance of the products and the financial markets in general. Understanding the products is an important part of becoming a savvy investor.
For more information about how the various types of shares differ and the pros and cons of each, read The ABCs Of Mutual Fund Classes.
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