Similar, But Different.
Art by Suharu Ogawa
hen selecting a mutual fund for a defined contribution (DC) plan, sponsors may have several share classes to choose from, as a single mutual fund may offer more than one class of its shares to investors. Each share class represents a similar interest in the mutual fund’s portfolio with one main difference--the fees and expenses that are charged.
As fiduciaries, plan committees should pay close attention to the expense ratios of the various classes and consider which available class is least expensive for participants in terms of net costs. By checking the fee table in the fund’s prospectus, committee members can access the exact cost of each fund class. In some cases, the difference in share class expense ratios for a particular fund can translate to participants paying three times as much for using one share class over another, according to FeeX.
A plan will find particular share classes available to it based on whether it satisfies the eligibility requirements to invest in those share classes, respectively.
Another expense that varies among mutual fund share classes is load. Loads are commissions paid to intermediaries such as financial planners, brokers and investment advisers. As noted by the Investment Company Institute (ICI), “Sales loads are often waived for mutual funds purchased through 401(k) plans.” In such cases, neither the participant nor the plan pays the fees.
Unlike T shares, these are without sales loads or annual 12b-1 fees. They carry fees for investment management and administrative costs but do not include distribution fees. Advisory firms may add on additional service fees, and brokers set their own commissions for selling them, adding transparency for investors.
12b-1 fees: Also called distribution fees, these are one component of a fund’s annual operating expenses and are a means to pay sales-related costs, such as compensation for investment professionals.
Asset-based sales fees/charges: Fees taken out of a mutual fund’s assets to pay for marketing and distribution of its shares. Asset-based sales charges include “Rule 12b-1” fees, which are dedicated to these types of distribution costs.
Back-end sales load or contingent deferred sales charge (CDSC): This fee is charged when mutual fund shares are sold. If, e.g., shares valued at $1,000 are redeemed, and the fund imposes a CDSC of 1%, the investor would receive $990. The fee normally declines, the longer the shares are held, and eventually is eliminated--often in the seventh year the shares are owned.
Expense ratio: A mutual fund’s expense ratio measures the fund’s total annual expenses expressed as a percentage of the fund’s net assets. It is also calculated annually as a percentage of an investor’s assets. So a balance of $10,000 invested in a share class with a 1.32% expense ratio would mean a $132 fee out of that balance.
Front-end sales charge: This fee is charged when mutual fund shares are purchased. If the investor spends $1,000 to purchase Class A shares, and the fund imposes a front-end sales charge of 5%, $50 will be charged on the purchase, and the investor will receive shares with a market value of $950. Depending on the size of his purchase, a breakpoint discount can lower this sales charge.
• Plan sponsors should pay close attention to share classes. Participants face larger or smaller fees depending on the class chosen even though their money is ultimately invested in the same fund;
• Most share classes come with varying fees that participants pay each year. Within these fees can be 12b-1 fees--charged annually for a fund’s marketing and distribution costs--plus front- and back-end loads; and
• T shares and clean shares are the most recent additions and were designed in response to the DOL fiduciary rule, to be more transparent than other share classes.