Some Thoughts on Share Classes

As already discussed, many funds offer three classes of shares: A, B, and C. Class A shares are the traditional type of share class, with a front-end sales charge. Class C shares, like Class B shares, do not impose a front-end sales charge at the time of purchase. The difference is that these shares charge the same higher distribution fee (one percent of assets) as do Class B shares, and these shares do not eventually convert to Class A shares. Therefore, the distribution fee is not subsequently reduced as it is with Class B shares, but continues on and on.

Class C shares have suddenly become popular with investors. From only eight percent of all load mutual shares sold in 1995, by year end 2000, Class C shares accounted for one third of all load shares sold. Given that kind of rapid growth, it is reasonable to ask what is going on here. Is this completely investor-driven demand for these shares, or are other forces at work?

Investors should realize that if it is true that funds are sold, not bought, one way or the other, they are going to have to pay. Mutual funds are so widely held and there are so many people in the business to make money by handling funds in one way or the other, it is only reasonable to assume that investors will pay for many mutual funds at some point ”be it up front, when they sell the shares, or during the time they hold the shares.

Class C shares do not carry the up-front load and also eliminate most of the deferred redemption charges. Investors presumably like them because they often do not like to pay a visible, up-front cost for the purchase of shares, or face a redemption charge for several years . Although Class C shares avoid both the front-end and back-end (except for the first year) sales charges, they definitely are not cheap. Not surprisingly, investors pay, one way or the other.

Investors pay for Class C shares by paying a much higher 12b-1 fee, and therefore each year they pay a significantly higher expense ratio than do investors in the Class A shares. Brokers often claim that the higher ongoing fees compensate them for the advice they give, but this is not a very strong argument because they often do not give ongoing advice to the purchasers of mutual fund shares.

Consider the following example. A $10,000 investment in Class C shares, assuming a return of 10 percent a year, will result, on average, in $560 less in the account than would the same investment in Class A shares over a 10-year period. Thus, it is clear that over longer periods (e.g., 10 years) investors are typically going to come out ahead with Class A shares relative to Class C shares.

Insights

Why have sales of Class C shares jumped so much in recent years? The answer, as we now are in a position to respond, goes back to the title of Chapter 8 ”mutual fund shares are sold, not bought. Over a period of a few years, brokers earn more from the sale of the Class C shares relative to Class A or B shares. The initial sale is easier because investors do not appear to be paying for the shares in the form of easily observable costs. Unless you know enough to ask the right questions, you might make a mistake that you will pay for year after year.



Mutual Funds(c) Your Money, Your Choice... Take Control Now and Build Wealth Wisely 2002
Mutual Funds(c) Your Money, Your Choice... Take Control Now and Build Wealth Wisely 2002
ISBN: N/A
EAN: N/A
Year: 2004
Pages: 94

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