Clean shares could revolutionize the fund industry

Divorce distribution and management fees

Feb 2, 2017 @ 11:50 am

By John Waggoner

Clean shares will be an enormous game changer for mutual funds and the investment advisers who sell them.

“Clean shares” — a term borrowed from England — separate out the fees for mutual fund distribution from those for investment management. The shares have no built-in commission or 12-b(1) fees, and intermediaries can charge for their services separately.

The American Funds got permission to roll out clean shares from the Securities and Exchange Commission last month, via a no-action letter to the Capital Group, the American Funds' management company. The Los Angeles-based fund behemoth calls its version of clean shares F3 shares.

Janus Capital (JNS) filed for P and Z share classes last month. The P shares, similar to other firms' T shares, have lower commissions than existing A shares. The Z shares are the Colorado firm's version of clean shares and will not include any embedded commission option, 12b-1, or sub transfer agent fees, which are typically paid to the intermediary.

Clean shares allow a fund company to offer a low-priced product — an advantage in the current cost-conscious atmosphere. “It's nice to think about having the commission and servicing fee completely removed,” said Russel Kinnel, director of mutual fund research at Morningstar (MORN). “I can choose what kind of service I want.”

In recent years, fund companies have trotted out fund shares with various levels of trailing fees and commissions, leaving intermediaries to sort out which share classes offer the right mix of compensation for themselves and the appropriate burden for investors. The Department of Labor's new fiduciary rules could make that sorting process all the more important — and difficult. The American funds already offer 18 share classes on some funds. “There has been a tremendous proliferation of share classes in the past 15 years, and clean shares could end up simplifying the process,” said Amy Doberman, partner at WilmerHale. “C shares could eventually look like dinosaurs.”

Are clean shares the only answer? No. “ETFs are clean shares also,” said Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA. ETFs also tend to be more tax-efficient than open-ended, actively managed funds.

And clean shares probably won't be embraced on discount brokerage platforms, such as those run by Charles Schwab and Fidelity. Those platforms charge funds a fee to be on the platform, and those fees wouldn't be part of a clean shares offering. But Schwab has just reduced commissions on its brokerage platform, and slashed management fees on its index funds.

Still, for big, active fund managers like the American Funds, clean funds could be a clean solution, Mr. Rosenbluth said. “The American funds, which have strong presence within the advisory world, also have a strong number of funds that have beaten their peers,” Mr. Rosenbluth said. “For an adviser who favors active management, the American funds probably should be on list of funds to consider.”

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