Fiduciary and the “B”

Mutual funds are now closing ‘B’ shares left and right, leaving one to ponder if this is because of demand for fiduciary responsibility in the financial marketplace.

            Salespersons, often disguised as “financial advisors,” sell mutual funds for a commission.  What many people don’t know is that the mutual fund industry organizes how these salespeople can receive their commission.  There are primarily three types of classes of mutual funds; A, B, and C.  All of these give the client access to the same manager and portfolio.

            ‘A’ shares are the most common type.  When a client chooses these, he or she will pay upwards of 5.75% of their initial investment in commission.  On top of that, the client will also pay an annual 12b-1 fee and management fee, usually greater than 1%, just for holding the mutual fund.  This means that the salesperson will receive the bulk of their commission at the beginning of the sale, followed by a smaller amount each quarter.  The ‘C’ share of a mutual fund does not have an upfront sales commission, but carries a higher annual management fee.  The ‘C’ share offers the salesperson the highest quarterly payout.

            The ‘B’ share of a mutual fund is often referred to as the back-end load fund.  This term is used because there is no fee charged for the client’s initial investment, but if the client wants out over the next 5 to 7 years, a penalty fee is assessed.  The salesperson in this case may still receive the bulk of the commission upfront from the fund company, so the back-end fee is placed in order to make sure that the company can recoup their commission payment.  The ‘B’ fund also carries an annual management and 12b-1 fee, usually more than the ‘A’ share, and equal to a ‘C.’  If the client holds the ‘B’ share for the 5 – 7 year period, it will convert to an ‘A’ share. 

            In 2000, Morningstar reported that ‘B’ share mutual funds made up 7% of mutual funds offered.     9 years later, this number has dropped to only 1%.  The Wall Street Journal (WSJ) recently reported that Goldman Sachs, Allianz, and American Century have all exited the ‘B’ share market, citing low client demand.

            According to Larry Light of the WSJ, ‘B’ shares were created to compete with the no-load mutual funds offered by Vanguard and T. Rowe Price in the late 80’s.  No-load funds do not have any upfront fees and comparatively low annual fees.  Mr. Light’s WSJ article also states that the brokerage firms are tight lipped about why they are getting out of the ‘B’ share market.

            At the beginning of the article, I mentioned the term financial advisor using quotations.  This was to help explain the difference between the two current standards for financial advisors.  The brokerage houses (Edward Jones, AG Edwards, Morgan Stanley, etc.) are not held liable if they sell the client a product that isn’t in his or her best interest.  The client only has to be ‘suitable’ for the investment.  (For more information about what this means, follow this link for an article on the Cruel World of Financial Advice ).  On the other hand, an Independent Advisor is required to put the client’s interest first.  This is called fiduciary responsibility.  The Obama Administration believes that every advisor should be held to a fiduciary standard.  On this point, I agree with the President (for once).  Brokerage houses are fighting this fiduciary standard because when they look at the bulk of their “tool box,” they see that this requirement would wipe out their under performing overpriced products.

            So is the “lack of demand” for the ‘B’ product because brokers are cleaning up their act and ditching one terrible product to show that they really don’t need to be fiduciaries to have the client’s best interest at heart?  And so they can shill other overpriced products instead?  Or, are investors wising up and letting “advisors” know that these are bad investments?

            In my opinion, ‘B’ shares were never really good investments.  In fact, the regulators capped the maximum that could be placed in a ‘B’ fund at $50,000.  They probably wanted to do away with them completely, but, as things often go, the big brokerage lobbyists worked a compromise to keep these unfair investments alive.