The trouble with fund share classes is even the experts don't understand them. God help the rest of us. Gretchen Morgenson at The New York Times wrote an article about fund share classes that tells us fund investors are wise about avoiding sales loads and that the poor B class fund is much maligned, but often the best choice:
While the bulk of mutual fund investors wisely choose no-load funds — 73 percent in 2006, according to the Investment Company Institute — $37 billion went into funds with loads.... One message comes through loud and clear from a trip through the analyzer: There is no such thing as the right share class for all investors. Indeed, one of the most intriguing findings is that Class A shares, the most commonly sold class today and the one usually characterized as the best value for individual investors, are often more expensive than B and C shares.... Class A shares are typically viewed as cheaper because their lower operating expenses are thought to offset their upfront sales loads, which can run to 5.75 percent. In 2006, such shares accounted for 51 percent of all load fund sales, versus 13 percent in 2002. Finra’s fee analyzer shows how wrong this conventional wisdom can be."
The article then proves this point by running a few load funds through an online fund fee calculator available by the newly re-branded Finra, aka NASD, available here. Unfortunately, in this case conventional wisdom was true: B class funds are for clients of questionable brokers and often the worst class to chose. This should come as no surprise because brokers looking to dupe clients is exactly who B class funds were designed for in the first place. The B class load was created to hide the obvious 5.75% front end sales commission that is whisked away from your account when you buy a load fund. People tend to notice when $575 of their $10,000 investment goes poof by their first statement. With the threat of no-load funds growing, the mutual fund industrial complex invented a load fund that looked like a no load fund. Of course, the fund companies where not going to build a cheaper fund class that paid brokers less in commissions, so they hid the 5.75% commission in a high yearly "distribution" charge of 1% on top of the ordinary annual fund costs. But how, pray tell, do fund companies prevent a shareholder from selling in a few years and avoiding the full 5.75% commission? With a contingent deferred sales load, or CDSC. This fee often starts at 5% and falls as the years roll by. At no time are you going to get out and save that much over an A class fund. Then how come some funds are cheaper to own as B class funds than A class funds as the article claims? Simple: the example funds are not typical load funds. Every load fund family has a slightly different way of levying the loads. Whether a B class is better than an A class for a particular fund often breaks down to the spread between the 12b-1 fees. Normally A class load funds have 0.25% 12b-1 fees and B class funds have 1.00% fees. In such a case the A class is almost always the better class when your time horizon is more than a couple of years. When the 12b-1 fee is 0.35% on the A class it is possible for a few years the B class will be the better class - and often not by much. If you review the largest load funds out there, it is clear the typical spread makes the A class the better choice. The prospectus fee table confirms this. American, PIMCO, Legg Mason, Davis, Van Kampen, and Franklin funds typically have the 0.25/1.00 12b-1 split. When you factor in that larger investments - either in a single fund or across the same fund family - can qualify for reductions in A class sales loads, the A class becomes the far superior choice. Crooked brokers use B class funds to avoid giving wealthier clients A class discounts in addition to hiding the loads from sight. We have no hard numbers on this, but from our own discussions and emails with hundreds of fund investors, most have no idea they are in a load fund when they are in a B class fund - which was the original purpose of the invention. Success! If you must go load, most of the time C class funds are best for very short term investments of under three years, and A class shares are better for longer term investments over three years. Occasionally (rarely) a B class is better for around 3-6 years if the CDSC is low (under 5% to start) and/or the 12b-1 is higher than 0.25 on the A class or lower than 1% on the B class. LINK
