Dwindling assets and intense regulatory scrutiny continue to take their toll on mutual fund B shares, which at the current rate of attrition are likely to become nearly extinct inside five years.
Since 2001, investors have been yanking more money out of the controversial share class than they have been putting into it. Last year alone, net outflows from B shares totaled more than $57 billion, according to Financial Research Corp. of Boston.
And if the current pace of outflows continues, another $44 billion will bleed out of B shares by the end of the year.
"We definitely think that B shares will be gone completely at some point," said Sam Campbell, director of research at FRC. "I guess it's a matter of how quickly that happens. I would think that in five years, the numbers we will be talking about will pretty well be down to something that is insignificant."
Burton Greenwald, a Philadelphia-based fund consultant, agrees.
"B shares are a dinosaur," he said. "I think the industry has enough flexibility in pricing that the B share option doesn't need to be there."
That said, it will be a while before B shares disappear entirely, said Scott Smith, a senior analyst for the intermediary practice at Boston's Cerulli Associates.
With fewer buyers and sellers, something dramatic would have to happen for B shares to stage a comeback, he said.
"I don't see why they would, in the near future," Mr. Smith added.
FRC's data reflect sales of B shares as well as their conversions to A shares.
"I think you'll see a decrease in outflow going forward because the asset level has declined to less than $250 billion," Mr. Campbell said.
Today, B shares comprise about $235 billion in assets, he said.
B shares provide a back-end load, meaning investors pay no sales charges unless they sell fund shares within a given period. B shares were devised to give brokers ammunition against no-load funds and the growing ranks of independent advisers who charge a fee rather than a commission.
Mutual fund companies liked B shares because they discouraged investors from pulling money out of their portfolios
At the beginning of the decade, however, the sale of B shares came under fire as the Securities and Exchange Commission and NASD — which recently merged with NYSE Regulation Inc. to create the
Financial Industry Regulatory Authority of New York and Washington — cracked down on the practice of pushing B shares over more-suitable classes.
Regulatory pressure heightened in 2004, which resulted in an outflow from B shares of more than $69 billion in 2005 — compared with $48.9 billion the previous year.
Meanwhile, the industry began to institute its own restrictions on sales of the shares.
For example, many fund companies and broker-dealers capped the amount investors could spend on B shares at $50,000 or $100,000.
"Even if a fund company had their maximum at $100,000, more than likely the distributor has rules in place that even wouldn't allow their advisers to sell them at those levels," Mr. Campbell said. "That has greatly curtailed the amounts they could have used."
Other fund companies — such as
Franklin Templeton Investments of San Mateo, Calif. — stopped selling B shares altogether.
"Many new firms are launching with just A and C shares and no B at all," said Mr. Smith. "Of the platform business, you usually only have A shares."
Also contributing to the decline of B shares is the shift from commission-based compensation to fee-based compensation.
"I don't like investments that have a surrender charge attached to them," said Tim Maurer, director of
financial planning at the The Financial Consulate Inc. a fee-only advisory firm in Baltimore. "Once they're sold, there is no responsibility left on the shoulders of the advisers to do anything for the client."
Still, there is room for commission-based sales, particularly among investors with small portfolios.
"There are still pockets in most firms for commission," Mr. Smith said.
The American Funds, advised by Capital Research and Management Co. of Los Angeles, continue to enjoy relatively robust — though steadily declining — B share sales. Last year, net flows into B shares at the firm totaled $1.037 billion, down from $2.46 billion the previous year.
Net inflows into B shares totaled $333 million for the year-to-date period ended Aug. 30 at American. That compares with $780 million for the corresponding period a year earlier, said FRC.
"How an individual chooses to work with and compensate their adviser for the advice he provides is really a decision between the investor and the adviser," said
American Funds spokesman Chuck Freadhoff. "By offering our funds across all share classes, we are leaving that decision where it should be."
American Funds does, however, have a purchase maximum of $50,000. "Like most fund companies, we have a limit beyond which a sale in B share would have to be a sale in A share, because of the break point," Mr. Freadhoff said.
Sue Asci can be reached at [email protected].
