As the mutual fund industry faces potentially huge changes to the way it does business, BlackRock is pressing the Securities and Exchange Commission to take measured steps to ensure that smaller investors do not get shut out of whatever marketplace emerges from the new policies.
“Investor choice has been at the heart of the mutual fund industry since its earliest days,” BlackRock Vice Chairman Barbara Novick said in a letter to the SEC on Monday. “Proposed changes will reduce product choice, especially for smaller investors and smaller defined contribution plans. Equally important is investor choice when it comes to investment advice and services, and how to pay for each.”
Novick’s letter discussed an array of proposals, including increased fee transparency for investors, and promoting competitive pricing. She started out by taking aim at limiting fund sales charges, and put a lot of emphasis on that point.
On that subject, the SEC wants to restrict cumulative ongoing sales charges to an amount that equals the maximum front-end load charged by any class of the relevant fund. Novick’s concern is that smaller investors might get pushed out of the marketplace for professional investment advice, if certain market dynamics develop out of implementation.
Novick said a typical mutual fund’s C shares carry a 25-basis-point ongoing fee for shareholder services and a 75-basis-point ongoing distribution and sales support fee, which compensates brokers for their ongoing client service.
Under the proposals, if the funds also offer A shares with a sales charge of 5.25%, the C shares could charge the 75 basis points for seven years, and would have to convert to a class that is akin to load-waived A shares. “For longer-term investors, brokers will no longer earn the ongoing 75 basis points of revenue, which could impact service levels for Class C investors,” Novick said in the letter.
If broker-dealers end up losing money on those fees, they will eventually compensate by serving clients on advisory programs called wrap accounts. Under that scenario, the programs pay ongoing wrap fees to the broker-dealer that encompasses both investment advisory fees and sales compensation on the purchase and sales of wrap account investments, including mutual funds and exchange-traded funds, Novick said.
The wrinkle here is that wrap accounts tend to attract investors with higher balances than typical fund investors, and who seem to be willing and able to pay the typical 1% management fee, in addition to the cost of the underlying funds and other investments in the account.
“Smaller investors could be harmed by this shift from commission-based fees to asset-based fees, as their wrap account fees will likely exceed the 12b-1 fees they are now paying,” Novick said.
Right now, investor choice abounds, she said. Smaller investors who want assistance from financial intermediaries, yet who cannot afford to invest through a wrap account can still get professional assistance through C share accounts. If the new regime is put into place, however, smaller investors will either be pushed into those C share accounts or be forced to give up professional advice altogether, if they cannot afford it.