The common practice of revenue sharing, where mutual fund companies pay brokers to tout their funds to clients, eventually hurts investors, according to Morningstar columnist Eric Jacobson writes. Even though revenue-sharing payments to brokers are made from mutual funds' own coffers and not from the funds' assets, investors are shortchanged because brokers are more likely to promote funds that pay them to do so rather than funds which offer the best deal to investors.
"The reality is that fund companies pay up for precious access to brokers, and those brokers are almost always limited to selling funds that have paid up," Jacobson says. For instance, he points out Merrill Lynch notes that "funds that do not enter into arrangements with Merrill Lynch are generally not offered to clients."
While not illegal, the practice of revenue-sharing has come under the microscope of the SEC and other regulators for the conflict-of-interest problems it poses. Regulators are pushing for heightened disclosure rules, which would provide more transparency to revenue-sharing deals.
Jacobson notes that in today's times, it is difficult to place blame on mutual fund companies for participating in revenue-sharing arrangements. That is because a good chunk of fund companies sell their funds via intermediaries such as brokerage firms and "those who try to 'stay above the fray' would find themselves locked out," Jacobson points out.
He says that an added problem with revenue-sharing arrangements is that they are usually secretive, which makes it difficult for investors to discern the motives behind the sales of certain funds.
He notes, however, that banning revenue-sharing altogether is not likely to solve the problem. That's because he expects a ban to lead to higher front-load fees incurred by the investor, in an effort by fund companies to attract brokers via greater financial incentives. At least for now, Jacobson says, improved disclosure is sure to help investors greatly in figuring out the motivations of their brokers.