Designing the most appropriate share class can be an underestimated component of a mutual fund manager's sales and marketing strategy. In an environment of increased fee-for-advice models, asset-based fees at the major platforms, and heightened SEC scrutiny on distribution payments, designing the most appropriate share class plays an increasingly important role. Having the right share class should balance the total expense ratio cost and the distribution strategy for the fund, and ultimately impact the fund's total expense ratio and the manager's profitability.
In 2013, the SEC's National Exam Program published its Examination Priorities for 2013, which included the review of fund expense structures to see if funds are misusing their 12b-1 fees or using other expenses to cover the costs of distribution, i.e. distribution in guise.
This scrutiny has led some managers and platforms to re-examine the setup of their distribution, shareholder servicing, and other expenses.
As the industry races to reduce fund expenses in efforts to remain competitive, implementing a share class that supports the distribution and shareholder servicing costs that many platforms require is extremely challenging. From an active money manager's perspective, a fund must be priced in a way that balances the following components: 1) management fees 2) shareholder servicing fees 3) 12b-1 4) administration 5) other expenses.
While the total expense ratios for some asset classes can support higher overall expenses, such as alternatives or small caps, most fund expense ratios need to be in range or below its peer group.For these reasons, and for the overall success of the fund, striking this balance can be more of an art than a science.
Wirehouses and broker/dealers continue to offer A Shares with loads attached to their funds. While this business is generally waning, managers should ask if it makes sense to offer an A share with a load to ensure that they have an opportunity to sell to those advisors that continue to use them. Additionally, investment managers can waive their load to offer the fund "A Load Waived" on platforms that are no load and do not have a transaction fee, but this may require board approval and/or a change to the fund's prospectus disclosure.
The RIA channel generally requires a No-Load Share Class and/or Institutional Share Class to have full distribution on the main RIA custodial platforms, such as Schwab and TD Ameritrade.These platforms often charge an asset based fee to support the fund on the platform, thus requiring either a shareholder servicing fee or payment from the investment advisor directly to cover the costs that go beyond the funds 12b-1 plan.
Consultants that drive funds to recordkeeping platforms may require an institutional share class, a no-load class that has a 12b-1, or an R share, such as the popular R6 share class. R6 share classes do not offer any recordkeeping offset fees (revenue share) for recordkeeping administrative expenses.Getting started with the right questions. Having a discussion with your funds distributor can help increase your knowledge and ensure that you are taking all factors into consideration in advance of your launch. Your funds distributor will help you answer the following questions, as well as questions specific to your strategy:
* Where will I sell this fund?
* Do I have a wirehouse, retirement, RIA or broker/dealer sales agenda, or a combination of these?
Reviewing share class flow data of the various intermediated channels can give insight into what share class may be appropriate for your distribution strategy.
Wirehouse platforms are moving much of their business to fee-based advisory programs, so offering a lower cost share class, such as an Institutional Share Class, is becoming more of the norm, versus offering only an A share with a load.
* Did a consultant suggest we launch a fund for DC/DB clients?If the fund is largely going to be sold in the institutional or ultra high net worth market, a retail share class may not be necessary. An I share or R6 share would be preferred, particularly in the large plan 401k market.
*Am I willing to take a lower investment advisory fee for distribution opportunities?
Managers can pay some platform fees directly out of their own investment advisory fee.
Being consistent in offering a fund with similar or lower expenses than its peers is important to mutual fund boards. Peer group reviews of competitor Investment advisory fees and expense ratios is an obligation under Section 15(c) of the Investment Company Act of 1940, however some managers are reluctant to reduce their investment advisory fee due to distribution fees that cut into their margins.
While no share class can meet the needs of all distribution channels, it is critical to spend time to develop a distribution strategy that takes into account individual share class requirements.Doing so can save valuable time and resources down the line as fund families seek to engage with platforms, obtain board approval, and comply with SEC requirements.
Jonathan Dale is a distribution director at SEI.