Since their inception in 1984, the number of total share classes in the mutual fund industry has risen to about 24,000, or an average of about three per fund for the 8,000 funds in existence. There are now A, B and C shares for retail investors as well as several classes of no-load and institutional shares. But the number of share classes seems to have mushroomed beyond all reason in some cases, as there are now funds and fund families that have nine to 18 share classes available. So what is really driving the creation of so many share classes?

Share-Class Hype

At first, the different classes of mutual fund shares were simply divided into three basic categories. A shares assessed a sales charge at the time of purchase while B-shares carried a back-end surrender charge schedule along with higher annual fees. C shares then became a way to pay a small charge up front and another small charge on the back end if the investor redeemed the shares within a certain period of time, such as 18 months. Then other classes of shares for institutions and fee-based advisors began to appear and the number of share classes steadily increased. (For more, see: Mutual Funds Commonly Found in Retirement Plans.)

Most fund experts say that the number of share classes that are available at this point is driven more by marketing efforts than anything else. Many of these share classes are supposedly geared to a specific segment of the market, such as retirement savers. A large number of fund companies have introduced “R” shares to cater to this group, but the underlying funds that come in this share class are no different than their previous cousins-except that many of them come with additional costs and fees.

For example, John Hancock came out with an “R” class of share in 2003, which charged a hefty 50 basis points each year for what it labeled as “marketing expenses” with another 25 basis points authorized to be charged if necessary in order to cover certain “other services” to shareholders. However, most if not all of these three-quarters of a percent of income will go into the pockets of the brokers who sell these funds, or else the administrators of the retirement plan or the employer sponsoring the plan. This can result in a tidy stream of trailer income for those who work behind the scenes. In many cases, the plan participants are unaware that they are paying these fees even if they were provided a prospectus at some point. And, of course, when John Hancock introduced this new line of shares, it neglected to mention the new fee structure in its advertising. (For more, see: These are John Hancock’s Top Funds for Retirement.)

A Common Trend

John Hancock is by no means alone when it comes to multiple share classes. The Strategic Bond Fund offered by American Funds has a whopping 18 share classes, with several being targeted at retirement investors. MFS has 13 share classes and Putnam Investments comes in behind them with nine. Most of these share classes have been fine-tuned to their specific target markets, such as for brokers, fee-based advisors, retirement plan participants and retail investors.

David Snowball, who publishes the website The Mutual Fund Observer, says that the various share classes are just really good marketing tools. He cites the advantages that fund companies such as American Funds can provide for those who work with retirement plans as an example. “They allow you as a plan administrator to feel like you're getting something special — say, the R3 class, not those common R2 shares your competitors have. And they allow the fund company to adjust their expenses to different parts of the market. The American Funds are the most finely tuned asset-gathering and retention operation I can imagine.”  (For more, see: American Funds vs. The Vanguard Group.)

In an effort to explain the rationale behind the strategy used by American Funds, Snowball referred to the strategy that was embraced by Oakland Athletics manager Billy Beane in 2002. “It's a bit like a Moneyball operation. They're not trying to win games by signing the biggest slugger — they're trying to find little things that tilt in their favor by a fraction.” And while the blizzard of fund share classes may leave investors a bit bewildered, they seem to be working rather well for the fund companies, as the amount of assets under management across all forms of shares has continued to grow as the years go by.

The Bottom Line

Despite the confusion that they commonly create, the number of share classes that are offered by mutual fund families will most likely continue to grow over time as fund companies seek to target new specific segments of the market. (For more, see: Advising FAs: Explaining Mutual Funds to a Client.)

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