MUTUAL FUNDS / RUSS WILES : The Other Side of the Debate on Sales Charges

This story is brought to you in the interest of giving equal time to opposing viewpoints. The topic under consideration is load versus no-load mutual funds, as seen from a broker’s perspective.

It’s no secret that a lot of securities salespeople are upset over the preference no-load mutual funds often receive in the press. They argue that the load or sales charge is only part of the overall investment equation--and not a very important one at that.

Several of these complaints were ably expressed in an article by Robert Fischer, an investment executive and certified financial planner with the brokerage Legg Mason in Richmond, Va. The article ran in the August issue of Registered Representative, a national magazine for brokers based in Irvine.

Fischer asserts that many investors are better off purchasing mutual funds through a commissioned salesperson, even if they must pay for the privilege.

That’s a fair statement. Clearly, not everybody has the time, inclination or skill to pick and monitor their investments. Nor should brokers and financial planners be expected to dispense free advice and assistance.

But some of his other comments are more controversial and highlight the misinformation that’s out there on both sides of this touchy issue.

“Controversy is what makes a horse race,” Fischer said in a follow-up interview. “But I don’t think (the broker’s) perspective has been shown before.”

He largely blames this on the press for harboring a bias against load funds and brokers.

“The biggest myth the financial media preaches is that you’ll generally have better fund performance if you buy only no-load funds,” Fischer writes.

Is he right? In a sense, yes.

The whole load versus no-load performance question has been studied plenty over the years, without any conclusive evidence either way. Certainly, it’s better to have a superior load fund than a laggard no-load.

Unfortunately, performance can’t be predicted accurately, so it’s hard to say whether a particular load portfolio ultimately will justify its costs. Many haven’t.

The only performance-related factor that can be predicted is the sales charge itself. Purchase an up-front load portfolio and you know you will be in a hole right away--typically 3% to 6% of the initial investment, perhaps more.

So the question really isn’t whether no-loads are superior performers--it’s whether a broker can recommend a load fund that can more than compensate for the sales-charge drag.

Fischer further notes that “larger investors can frequently obtain fund shares at a lower cost through a broker than by purchasing a no-load.” This is because load funds cut their commission rates on big purchases.

How big is big? The first discount on a load fund typically doesn’t come into play until a person invests $50,000 or so. The load declines further at successively higher “breakpoints,” but often won’t phase out completely unless the investor can sock away $1 million or more.

On the topic of costs, perhaps Fischer’s most controversial statement is the following: “Clients must understand that the best products and services never come at the lowest prices.”

A blanket statement like this doesn’t hold water. Some no-load funds do offer superior performance at a reduced cost.

An obvious example is the Vanguard Index Trust 500 Portfolio, a no-load with the lowest annual expenses of any stock fund. It has managed to beat 60% of all funds over the past year, 85% over five years and 87% over 10 years, according to Morningstar Inc. of Chicago. Other no-loads have also demonstrated superior performance over time, just as many commissioned products have.

Another controversial area Fischer addresses deals with investment timing. “Investors who purchase funds through brokers may be less likely to get into a fund just as it’s peaking,” he writes.

Fischer’s reasoning here is that no-loads rely more heavily on advertising than their load rivals, and that funds are likely to do more advertising when their performance has been hot, luring investors at the worst time.

He’s probably correct on this point.

Even so, brokers are human too and also can fall into the hot-fund trap. For example, brokers helped to channel billions of dollars into the short-term “multi-market” bond portfolios over the two years leading up to September, 1991. Then, the European monetary system unraveled, and these investments got bruised.

Few no-load groups offered this type of fund at the time, and not many have added one since.

Without pointing any more fingers, the moral here is that it can be risky to buy any mutual funds based on short-term performance results.

On the subject of asset allocation, Fischer observes that a proper asset mix is “infinitely more important to investors than whether or not there’s a cost to acquire a mutual fund.”

This is true, and a good broker can be invaluable for people who need help spreading their fund holdings among stocks, bonds and cash within a framework that reflects their goals and risk tolerance.

There’s nothing particularly magical about broker allocation models. Investors who take the time to learn the basics can construct a decent financial plan on their own, using good no-load mutual funds. But many people won’t make the effort, and for them a broker can be useful.

In short, investors who need help should be willing to pay for it, provided they get good service in return.

What constitutes good service? Fischer believes investors should expect to deal with a knowledgeable professional who’s willing to take a close look at their circumstances, ask the right questions and stay in touch on a quarterly basis, at least.

“The reason you buy a load fund is for the broker,” he said.

Briefly . . .

Dreyfus Corp., Franklin Resources and Charles Schwab & Co. have been accused of deceptive advertising by New York City’s Department of Consumer Affairs.

The agency charged Dreyfus with failing to disclose in a promotional brochure that the convertible securities it can buy for its growth-and-income fund might, in fact, be junk bonds.

Franklin was criticized for claiming it offered guaranteed income on its Valuemark II annuity, while Schwab was accused of not disclosing that some of its funds have transaction, management and various other fees.

The three companies face fines of up to $500 per violation.

Dreyfus disputes the charges on the grounds that convertibles are best classified as equity investments, not bonds. Schwab also disagrees with the department, although a Schwab spokesman said his company will change the offensive ad to clear up the point in question.

A Franklin representative said her firm is working to resolve the dispute through discussions with the department.

Mutual fund ads are routinely cleared by the National Association of Securities Dealers, yet the department charged that many are written in financial jargon that consumers might not understand.