Sorting Out the ABC’s of Multiple-Share Classes

One of the curious aspects of mutual funds these days is that it’s hard to get a universally accepted count of them.

Researcher Lipper Analytical Services, for instance, counts about 8,000 mutual funds, while the Investment Co. Institute, the industry’s trade group, says there are 5,600. How can two such tallies be so far off?

The answer involves multiple classes of shares. About 1,900 funds issue more than one type of share, with different fees attached. Lipper counts each as a separate portfolio; ICI doesn’t.

The idea behind multiple-share classes has been to give clients who work with a broker or financial planner a choice of how they want to pay a commission. But the result is an added layer of potential confusion for shareholders.

“It gets confusing even for brokers and planners,” says Jay Penney, a broker at the Acacia Group in Phoenix. “It throws a monkey wrench into the computation of returns.”

Because mutual fund returns are reported net of most types of fees, and because each share class carries a different level of fees, a single fund with the same manager can have two or more performance results. In any year, the returns won’t vary much, but they can add up over time.

For example, the A shares of the Alliance Balanced portfolio rose 28.3% over the three years through June 30, while the B shares of the same fund increased just 24%.

There is no official standard on how the shares are labeled. But on A shares generally, clients pay a one-time front-end charge of 3% to 6% or so, with little or nothing tacked on in terms of 12b-1 expenses--an ongoing marketing charge of up to 1% each year.

“If you’re a long-term investor and think you can stay put for the long haul, I’d choose the A shares,” says A. Michael Lipper of Lipper Analytical Services, based in Summit, N.J.

In addition, if you’re investing a large wad of cash into a fund--several hundred thousand dollars or more--A shares are usually your best bet. That’s because big purchases qualify for a load discount, with no increases in other fees. Million-dollar investments often go into A shares entirely commission-free.

Conversely, B shares carry no up-front sales charge. But they do come with a potential double whammy: An ongoing 12b-1 fee, plus a back-end load if you sell within the first few years.

The back-end charge typically starts at 4% or 5% if you sell in the first year, declining by 1 percentage point each year until it phases out. All of your cash goes to work immediately in B shares, but higher annual expenses erode your returns.

“B shares often appeal to newer fund buyers who don’t see the reason for paying a charge before they benefit,” says Geoffrey Hyde, a senior vice president for Alliance Capital Management in New York.

Investors who stick with a fund’s B shares for many years could wind up paying a lot more in cumulative 12b-1 fees than they would had they forked over the front-end load on A shares. But many fund groups automatically convert a person’s B shares into A shares, without requiring payment of any front-end load, after a number of years.

“I’ve always felt the B shares are a rip-off,” Penney says. “But they might be all right if there is an automatic conversion to A shares.”

The caveat here is that conversion may not happen for many years. Also worth remembering: B shares aren’t commission-free investments, even if they are sometimes sold as such.

Confused yet? There are more wrinkles.

C shares are often the type that levy a relatively high “level load” of about 1% each year, often with a one-year back-end charge of 1%. This route makes sense for people with a reasonably short-term outlook, says Penney.

Then there are D shares, which sometimes feature another combination of charges, often a front-end load plus one of the other fees. Of the four main choices, D shares are least common. In some cases, B shares convert to D.

Certain funds also carry other share categories that might not be available to all investors. Y shares, for example, are often the label used for investments by institutions such as pension plans and their members. They frequently offer a good deal, combining moderate ongoing expenses with no front-end charges.

Z shares, often the best bet with no commission-related costs at all, are reserved for fund-company employees.

When selecting among the more common A, B and C choices, the key question is how long you plan to hold an investment--something that’s not always easy to predict.

In designing these charges, fund companies try to offer choices without making one share class a clear-cut favorite over the next.

“If you take about a five-year view, the A, B and C options all work out about even,” Hyde says.

Each fund’s prospectus or disclosure statement provides a cost estimate for the various share classes over different time spans.

In short, it’s not easy to choose among different share classes. This predicament might even be more problematic than deciding which fund to buy.

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John Wallace, who built a superb record at the helm of two Oppenheimer mutual funds, has switched allegiances to Robertson Stephens & Co. and now runs that firm’s new growth and income portfolio, which debuted July 12.

As head of Oppenheimer Main Street Income & Growth, Wallace beat the Standard & Poor’s 500 index by more than 20 percentage points from 1991 through 1993. He outperformed the market by a smaller margin in each of those years as manager of Oppenheimer Total Return Fund. Wallace will target small- and medium-growth stocks at the helm of Robertson Stephens Growth & Income (800-766-3863), a no-load fund.

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How many mutual funds are needed to construct a well-rounded portfolio? “Eight is enough, but 11 is better,” says the Value Line Mutual Fund Advisor.

To cover all of the major asset classes, the New York publication suggests one fund in each of these four stock market categories: growth, growth and income, small company and international.

It also recommends at least four types of bond funds, centering on the corporate, government, municipal and government-mortgage categories. For added diversification, it suggests investors further split their corporate, government and municipal funds into separate short- and long-term portfolios.

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Share-Class Math

Many broker-sold mutual funds issue various categories of shares, each offering a different way to pay the sales commission.

Although the nomenclature often varies by fund company, Class A shares typically levy a front-end sales charge or load, with a small or no 12b-1 fee. Class B shares feature a larger 12b-1 fee, plus a back-end load triggered if investors sell within the first few years. Class C shares also feature an ongoing 12b-1 fee with only a modest back-end charge, and Class D shares combine a front-end load with other charges.

Here’s an example using certain Merrill Lynch stock funds:

* A shares: 5.25% front-end charge.

* B shares: 1% annual 12b-1 fee; 4% maximum back-end charge.

* C shares: 1% annual 12b-1 fee; 1% maximum back-end charge.

* D shares: 5.25% front-end charge; 0.25% 12b-1 fee.

In this case, the Class B shares convert automatically to Class D shares after eight years, without requiring payment of the front-end charge. This conversion feature explains why a person might want to buy Class B shares instead of Class C shares, which otherwise would be a less-costly choice.