Resale Market Proposal for Fee-Shy Investors

In recent years, the distinction between load and no-load mutual funds has become increasingly blurred. If Jack White has his way, investors will find it even harder to tell one from the other.

White, president of Jack White & Co., a San Diego-based discount brokerage, is working to create a resale market where fee-shy investors can purchase load mutual funds without paying the standard sales charge. If this market develops as he hopes, people who have traditionally gone the no-load route might start nibbling at various load products too.

Simply put, White’s plan involves matching a person who wants out of a load fund with another individual who wishes to purchase those shares. The buyer pays the ‘net asset value’ or NAV, as he would when investing in a no-load, plus a flat $100 transaction fee, regardless of the size of the order. The seller gets the NAV price, plus a portion of that transaction fee (most likely $25) as an inducement to unload shares in this manner.

All this comes as a welcome development for fee-conscious investors. For while load funds as a group don’t perform any better than their no-load counterparts, there are certainly individual standouts that would make a nice addition to anyone’s portfolio.

White’s brokerage has already started to match load-fund buyers and sellers on a limited scale. To get greater exposure and bring in more buyers and sellers, the company has applied for listing on the OTC Bulletin Board, a new electronic quote system operated by the National Assn. of Securities Dealers.

Through the Bulletin Board, stockbrokers around the country would be able to instantly look up bid prices on funds their clients might want to sell. “It will increase the size of the market by making our bids visible to the entire industry,” says White. “(Brokers) won’t have to call us to get a price.” His company expects to receive listing approval by the end of January; the NASD confirms the application is under review.

Assuming White gets this approval, he next needs to secure the cooperation of brokers, so that they will offer the shares of clients for sale in this market. That’s where the $25 payment to the seller comes in. Brokers have a fiduciary duty to get the highest price for their clients, White argues, and a bid of NAV plus $25 would beat what’s available by redeeming through the fund company.

Even so, there’s some question as to how enthusiastically a broker working for a competing company, especially a full-service firm, might want to use the system.

Also uncertain is how independent load-fund companies, who market their products through brokers, will react. The giant Franklin Group of Funds in San Mateo, Calif., so far has adopted a neutral stance to White’s program. “This kind of transaction doesn’t show up at Franklin as either a sale or redemption,” says spokeswoman Virginia Marans. “In our eyes, it’s just a transfer of assets from one investor to another.”

One reason fund companies might not care much is that they generally don’t keep the load anyway, says Dan Jamieson, editor of Registered Representative, the Irvine-based national trade magazine for stockbrokers. “Fund companies pay out anywhere from 70% to 100% of that load,” he says.

Brokers, who split this commission with their firms, could be hurt if their customers suddenly started to shop for load funds on the resale market. However, Jamieson doesn’t think this will happen to any large degree. “The reason people buy load funds is that they need help choosing among different investments,” he says. “That sales-charge market will always exist.”

Others agree. “If you can’t fix your car, you go to a mechanic and pay a large hourly rate,” says A. Michael Lipper of Lipper Analytical Services, a fund-tracking company based in Summit, N.J. Similarly, people who don’t know to define their investment goals, select funds and monitor performance go to a broker and pay a sales charge. “The load is not a particularly significant amount of money if you don’t know what you’re doing,” Lipper says.

As it is, no-load buyers account for only about 36% of all mutual fund sales, according to figures compiled by the Investment Company Institute, the mutual fund industry group.

White says the people most likely to shop for load funds on the resale market aren’t the typical clients of full-service brokers but rather sophisticated, knowledgeable individuals who like to make their own decisions--in other words, no-load customers. By opening up load products to these cost-conscious investors, White predicts his plan could help load-fund groups increase their assets under management and thereby boost their fee income.

As good as it all sounds, there are certain limitations that could turn off people from purchasing load funds on the resale market. For starters, smaller buyers might find the $100 transaction fee more of a hurdle than the regular sales load. You would pay just $80, for example, when making a $2,000 purchase through the standard channels in the Franklin Rising Dividends Fund, which carries a 4% load.

In addition, not all load funds would be available for purchase in the resale market--just those that carry an up-front sales charge. “Back-end load funds won’t qualify for our trading,” says White. And keep in mind that you still would have to pay the annual 12b-1 charge if you bought a fund that imposes this fee.

Then there’s the problem of finding what you want. Until the resale market gets large, there could be a limited availability of popular funds. It’s conceivable that some orders could take weeks to fill.

And don’t underestimate the possible legal or regulatory challenges to the notion of buying load funds without a load. Lipper suspects the idea could run afoul of certain securities laws that have governed mutual funds since Congress passed the Investment Company Act of 1940.

From the standpoint of investors, however, White’s resale idea appears to be a good one. Sellers of load portfolios would benefit by receiving a slightly better price for their shares. And buyers would enjoy a wider selection of funds from which to choose.

WHY PAY A SALES CHARGE

The efforts of Jack White & Co. to open up load funds to no-load buyers raises a fundamental question: Why are some people willing to pay a sales charge in the first place?

A 1988 survey of 1,000 fundholders by the Investment Company Institute in Washington provides some answers. The ICI asked people to rate various attributes in terms of importance when investing in a mutual fund. As this table shows, individuals who buy load funds through a stockbroker, insurance agent, financial planner or bank tended to rate attributes such as advice and personalized service as relatively important.

For example, 33% of the people using brokers considered “initial/ongoing advice” as important, and 71% of the individuals buying through banks rated “advice on a range of products” as important. By contrast--and to no surprise--investors who buy no-load funds indicated that they are more fee-conscious.