The truth about T shares

Regardless of the future of the Department of Labor's fiduciary rule, it is clear that the fiduciary mindset is here to stay and will continue to be a catalyst for change. However, whether the future belongs to T shares is yet to be seen. T shares came to market as a quick response to the DOL rule so that commission-based brokers could continue to earn commissions. T shares aim to address one of the main issues targeted by the DOL rule: the conflict of interest that happens when a financial professional receives greater compensation for recommending certain funds to investors and, therefore, has more incentive to recommend those offerings. In that sense, T shares replace A shares, which generally have higher upfront commissions. By establishing a uniform front-end load — at 2.5% — and a 0.25% trailing 12-b(1) fee across funds, T shares level the playing field in terms of the potential gains financial professionals can receive based on the funds they recommend. T shares present certain drawbacks compared to A shares. For example, T shares do not offer as much flexibility within the same family of funds. If an investor wants to move from one fund to another within the same family, a 2.5% sales charge is incurred for each exchange. By comparison, investors who hold A shares may freely switch between funds of different asset classes, as long as they remain within the same family.

BREAK-POINT THRESHOLD

Another issue is the lack of rights of accumulation. While T shares do provide break points based on the size of a purchase — an investor can get a lower sales charge when purchasing a million shares, for instance — they don't offer the same break point after a certain threshold is reached. In other words, an investor who already has a million shares doesn't get the same price break on smaller, future purchases of shares. That said, T shares may prove to be a good option for particularly smaller accounts looking to hold shares over a longer period of time, as opposed to paying an annual advisory fee for shares purchased through an advisory account, or the maximum average front load of 4.85% in an A share.

CLEAN SHARES

A possible alternative to T shares is clean shares, which strip out all sales and marketing fees, thus unbundling the price of service and product and bringing a new level of transparency to the fees charged to investors. The Securities and Exchange Commission's no-action letter to Capital Group in January put things in motion for clean shares. The no-action letter confirmed that a firm that is not acting as a dealer could establish its own commission for facilitating transactions. This in effect expanded the definition of clean shares to include any fund that does not have any sales load or 12-b(1) fees built into its expense ratio and rendered institutional share classes — which have also become prevalent in fee-based advisory programs — clean shares.

DOL RULE

While this latest move by the SEC is likely to pave the way for greater utilization of clean shares, the elephant in the room, of course, is the timing of the implementation of the DOL rule. The rule's timing has the potential to change the course for clean shares by pushing the industry toward T shares. Transformation in the industry will continue. There will be important ramifications for all involved, as the move toward low-fee share classes gains steam.

A SHARES OBSOLETE?

In the long term, we anticipate some consolidation in the number of share classes available in the market. For example, it is likely that A shares will become obsolete in the advisory business. The question is which share classes will become the preferred choice for the industry. And the answer to that question depends on what happens to the DOL rule. T shares will likely take off should the DOL conflict of interest rule go into effect on June 9 — as we believe it will. However, any additional delays to the implementation of the rule would likely put a dent in the progress of T shares and provide clean shares with the time necessary to get off the ground. So, while it is too soon to call out winners, we can be sure that the status quo is not one. Rob Cirrotti is managing director of retirement and investment solutions at BNY Mellon's Pershing.