Choices With Dual Pricing Aren’t That Simple
Investors are having to learn their ABCs all over again or at least their A’s and Bs.
That’s because more mutual funds are being split into A and B shares. This dual-pricing arrangement gives investors a choice of how to pay a sales commission--either now or later.
“You have one fund, one pool of assets but two ways to play,” says Andrew Meyers, director of marketing for the Thomson Fund Group in Stamford, Conn.
Simply put, if you purchase a fund’s A shares, you pay the load or commission at the time of sale. With the B shares, you pay the marketing charge over many years in the form of a 12b-1 fee.
Either way, the fund manager, portfolio holdings, investment objective and just about everything else stay the same. (A 12b-1 fee takes its name from the Securities Exchange Commission regulation that allows fund managers a fixed surcharge for administrative costs.)
Dual pricing debuted in 1988 but really started to catch on just recently. Lipper Analytical Services counts 60 new or renamed A and B funds for the first nine months of 1991, well above the comparable totals for any of the previous three years.
If you buy no-load funds, you don’t have to worry about dual pricing. It applies only to commission-laden portfolios offered by stockbrokers, financial planners and other salespeople. However, most people don’t take the time to research, select and monitor mutual funds on their own. Load products continue to enjoy greater sales than no-loads.
Critics see dual pricing as an improvement but not an optimal arrangement. “People really shouldn’t be in either A or B funds, since no-loads are usually a better bet,” says Jonathan D. Pond, a Watertown, Mass., financial planner and weekly investment commentator on NBC’s “Today” show. But for individuals who prefer to work through a paid salesperson, dual pricing is welcome, he says. “Having a choice is certainly a positive.”
But it’s not always a simple matter to decide which of the two pricing methods is preferable. “There’s a tremendous amount of confusion regarding A and B shares,” says George E. Chamberlin, a Prudential Securities broker in Carlsbad who hosts a financial radio talk show. “With the B shares, people might assume they’re not paying a sales charge.”
Here’s how a typical fund might be structured: The A shares carry a 5% upfront load but no 12b-1 expenses, while the B shares feature a 1% annual 12b-1 fee, along with a back-end load that starts at 5% but phases down and out over five years. An investor would trigger the back-end load, which is designed to discourage redemptions, only if he sells shares during the period when that charge is still in effect.
Assuming that the investment is held until the back-end load expires, the two options might wash out. “Dual pricing is designed so that the investor should be indifferent economically,” says Mike Laughlin, marketing director for Alliance Capital Management in New York.
In reality, it doesn’t always work that way. Long-term investors--those who plan to buy and hold their shares for many years--would generally be better off with the A option. Why? Because a 1% or 1.25% annual 12b-1 fee can, over time, exceed the original upfront sales charge, especially if the investment appreciates.
Susan L. Malley, head of research and recommendations for Citicorp Select Investments in New York, points out that A shares are especially appropriate for larger investors. The reason: Most load funds will reduce the upfront charge (but not the 12b-1 fee) for big-ticket purchasers. This is a fairly common practice known as hitting a commission “break point.” People with at least $50,000 to invest will typically hit the first break point and pay less than the maximum sales charge, while larger purchases may result in additional discounts.
The B shares, on the other hand, may be more appropriate for smaller investors and people with shorter time horizons (assuming the back-end load isn’t excessive). As another plus, a broker who sells the B shares should, theoretically, be motivated to remain of service to his clients long after the purchase date. That’s because the broker stands to collect a 12b-1 payment each year an investor sticks with the fund rather than receiving a payout all at once.
“As the client’s assets grow, so do the broker’s commissions,” Meyers says. “This helps link the broker’s interest with that of the client.” Sales of his company’s funds are running 4 to 1 in favor of the B shares, which carry a low 1% back-end load.
It’s worth noting that a plan being considered by the Securities and Exchange Commission would essentially cap cumulative 12b-1 fees over the life of a mutual fund investment so that they don’t exceed what a person otherwise would pay in an up-front load. The SEC now prohibits 12b-1 charges greater than 1.25% a year, although critics such as Pond consider anything above 0.50% or 0.75% excessive.
If dual pricing isn’t enough, a handful of fund groups actually have three types of sales-oriented charges on the same product. For example, Alliance’s Multimarket Income & Growth Fund, a global balanced portfolio, features a 1% upfront load and a 1% annual 12b-1 fee, in addition to a 1% maximum back-end load for people who sell out during the first year. Laughlin terms this a “spread load” package, and he says these types of arrangements are becoming more prevalent.
Compared to decades past, when mutual funds could be divided pretty cleanly into the load or no-load camps, today’s products occupy many niches in between. More choices mean more potential confusion, so it’s important for investors to understand what they’re getting and what they’re paying in return.
A Vanishing Breed
Full-load mutual funds--those carrying the maximum allowable upfront fee of 8.5%--are becoming as scarce as gnat catchers. Due to competitive pressures, it’s now more common to find load funds with sales charges in the range of 4% to 6%, as the chart shows, although some of these funds also levy 12b-1 fees. Chart excludes no-load and B funds.
4: 1-1.9%
26: 2-2.9%
49: 3-3.9%
572: 4-4.9%
523: 5-5.9%
117: 6-6.9%
67: 7-7.9%
50: 8-8.9%
Source: Lipper Analytical Services
