New mutual funds under DOL fiduciary rule could save investors at least 0.50% in returns: Morningstar

T shares and clean shares increase transparency and reduce entrenched conflicts of interest, offering a cost benefit to investors, the fund researcher finds

Apr 18, 2017 @ 2:03 pm

By Greg Iacurci

New mutual-fund share classes being developed as a result of the Department of Labor's looming fiduciary rule will likely save investors at least 0.50% in returns when compared with the current selection, according to a new analysis published by Morningstar Inc.

Mutual fund companies have been rolling out new fund share classes — T shares and clean shares — in preparation for the rule, which raises investment-advice standards in retirement accounts such as IRAs.

These mutual fund breeds have compensation structures seen as less conflicted, and supplant the "uneven and opaque fee structure we observe with A shares," said report co-authors Aron Szapiro and Paul Ellenbogen, respectively the director of policy research and head of global regulatory solutions at Morningstar.

"Early evidence suggests that the asset management industry is adapting in ways that will benefit investors by reducing conflicts of interest and adding transparency," according to the analysis.

"We think that 50 basis points is a reasonable estimate of savings to investors from reducing conflicted advice," the report said. "Precisely how much T shares will save investors is an open question that we will be able to address more authoritatively after we have some experience with the new regime."

As an example, using a T-share over an average A-share fund could could equate to roughly $1,800 in extra IRA assets per $10,000 invested over a 30-year period, Morningstar said.

Morningstar anticipates mutual fund companies will create 3,500 new T shares in the coming months for IRA investors. Some companies such as American Funds, Janus and MFS offer clean shares, and Morningstar expects others to follow suit.

The reason for their emergence is the conflict between the traditional mutual fund structure and the DOL fiduciary rule, which requires financial institutions to set advisers' compensation in such a way that they don't benefit from recommending one fund over another to retirement investors.

The implementation date of the regulation, which was recently delayed by 60 days, is set to begin June 9.

The front-end sales charge on A-share funds varies depending on the fund and asset class, which creates a potential incentive for advisers to recommend certain funds that may not be in an investor's best interest but pay advisers a higher commission, the report said.

T shares, however, charge the same commission across all eligible funds, most of which will charge a 2.5% maximum front-end load, according to Morningstar. That also benefits investors because it's lower than the 5.75% commission that's most common maximum load for A shares.

Clean shares, though, are "the best way to enhance transparency" in the long term, according to the report, titled "Early Evidence on the Department of Labor Conflict of Interest Rule," published on April 13.

Such funds, unlike T shares, won't have sales loads or bundle in annual 12b-1 fees for fund services. Rather, they'll charge only an asset management fee and allow the brokerage to layer its fees on top.

Of the 0.50% in "ballpark" cost savings these funds will offer to investors, Morningstar estimates 0.30% will be attributable to "manager skill in the form of alpha" and 0.20% from reduced fees when compared to "conflicted advice."

In addition, Morningstar expects an additional 0.20% in savings due to the incentive to recommend an investment that's in the best interest of the investor. Investors are also likely to receive an additional cost benefit from broker-dealers cutting some funds from their shelves, especially ones that are higher-cost, according to the report.

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