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What’s the Matter with U – Part II

What’s the Matter with U – Part II

In part one of this post I opened the lid on the Pandora’s Box of mutual fund share classes (from A-Z, without U), currently floating around the industry; in part two we’ll examine why, beyond sheer confusion, this marketing practice is problematic.

Other than just being able to clearly identify the type of share class you are investing in, there are other issues with all multiple share classes. A lot of penalties have been imposed on firms by the SEC and FINRA for utilizing the wrong share class, either in retirement plans or Wrap accounts. With all the share class options available, is it any wonder they are being utilized improperly, either by design or by accident? Let’s look at some of the issues around using the wrong share class.

Using A shares in Retirement Plans – An A share usually carries a front end load (check out Pt I: are you sure it is an A share?). In many cases, a fund will waive the front end load when an A share is purchased within a retirement plan. But sometimes A shares are sold into a retirement plan and the load is not waived, when in fact it could have been waived. Or, the advisor to the plan puts the participants into a corresponding B or C share class which carry a more expensive management fee. Maybe it was done by design or maybe it was done by accident. But finding out if an A share sold in a retirement plan can have the load waived is not something you can just Google. FINRA has imposed fines and required restitution for firms that failed to take advantage of the load waiver when it was available.

Putting Load Waived A Shares in Wrap programs – This seems harmless enough: the fund agrees to not charge a load so you get a lower expense ratio with the A share than you would a B or C share. But the wrap program is imposing its own fee while the fund continues to pay out a 12b-1 fee. Better to go with a no load, non 12b-1 paying share class in the wrap program. The SEC just recently announced they are taking a closer look into whether advisors are putting the least expensive share class available into fee based programs.

Share Class Suitability – This has been around for a long time, back to when you typically only had A, B and C share classes to deal with, but it is still an issue today, just more complicated. Once an investor has selected a mutual fund to invest in, the next decision is which share class to purchase. This requires knowing the time horizon of the investor as well as the amount of their investment. Once these two facts were known, you could figure out whether they should invest in the A, B or C share class of the fund. But now, you’ll have to figure out which share classes are the A, B and  Classes, as well as look at all the other share classes offered in that fund, to see if they might qualify.

Conclusion

Confusion will continue to reign, without a set of standard share class indicators (across all funds), when trying to select the appropriate share class for an investor. Even with standardization of share classes, due diligence will still be required to make the appropriate selection. However, a move to standardization and simplification will remove some of the noise that exist today around selecting the most appropriate mutual fund share class for an investor.

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