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This strikes me as pretty consistent with the grumbles I've heard from small managers: little guys pay something like 40 bps to Schwab because they need Schwab while brand-name funds pay less because Schwab needs them. Managers don't want to price themselves out of the market but can't make it without supermarket distribution, so a fair number end up eating much or all of the cost themselves in the form of an ongoing fee waiver.
I owned Appleseed through the fund's back office when the E.R. was jacked up as described. That was my introduction to the system; you pay the higher NTF E.R. whether you buy the fund through the supermarket or not.
It shows that the fund added a 12b-1 fee (0.25%) to be effective April 2009, as M* implied. But what Appleseed did subsequently was hide that fee instead. In the March 30, 2009 prospectus Appleseed didn't add a 12b-1 fee. Instead it buried this fee in "other expenses".
It had been capping fees at 0.90%. To enable this additional 0.25% "other expense" to be collected, it had to raise the cap accordingly. But Appleseed didn't just raise its cap to 1.15% (i.e. add in the 0.25%), it raised the cap all the way to 1.24%.
So not only did Appleseed hide the fee (not show it on the 12b-1 line), it raised the fee even higher (by weakening its fee waiver).
Maybe this amount of information hiding was over the top, even for the SEC. Or maybe the regulations changed. Because in the current prospectus, there's verbiage about being charged a 0.25% Administrative Services fee. That fee is still buried within "other expenses" (there's no other line item that could contain it).
To Charles' point about all investors (even ones investing directly) losing - it's a matter of perspective. I prefer to say that there is a cost of going through an intermediary, and those who are doing so are actually winners, since part of their cost is being subsidized by those who invest directly.
Of course, Charles is right that the NTF system costs all investors money, and in that sense, all investors in an NTF fund (whether via supermarket or directly) are losers.
The NTF designation for a lot of funds is a huge deal. Without it, the smaller companies can find it very difficult to raise dollars and increase assets. Institutional class shares are almost always a better deal, even over short time periods, but most fund companies restrict the purchase of these with very high minimum amounts or to institutional relationships such as RIAs. There are some exceptions, where Fidelity or Schwab or TD will waive the minimum for larger individual clients, but these are fairly rare.
You might be surprised to know that we have some clients who object to paying a $25 transaction fee for a $25,000-100,000 purchase of a non-NTF fund. It takes some explaining that they are ahead of the game almost immediately, and even then, they still look at an NTF purchase as a 'freebie'. But as several MFO posters have already pointed out, this is not the case. NTF is the price investors pay to consolidate their holdings with one custodian instead of dealing with each fund company separately.
For sure those folks who have self-directed brokerage 401k accounts are glad to have NTF options, since smaller investment amounts would be devastated by ticket charges.
Reply to @BobC: In addition to your points Bob (and others). TF funds can be dollar cost averaged into (and out of) with no additional TF fees. One strategy I have used is to set up monthly sales of one fund and then I use these proceeds to buy additional sharesanother TF fund a few days later. It helps me reallocate and rebalance my portfolio with two very good TF funds that have lower ER than their NTF comparative share class. In some cases, only the TF fund is available at my brokerage...funds from Faiholme, Dodge and Cox, Wasatch, Franklin Templeton, and many smaller firms that choose not to offer their funds NFT.
Here's the math using two identical funds from T Rowe Price at my brokerage (not all brokerage fees are the same): PRWCX (ER=.71) is sold TF using my brokerage while the advisor shares is offered NTF PLCAX (ER=1.02). The ER differential between the two funds is .31 or $31 per $1,000. The intial minimum for both funds is $2,500.
The transaction fee is $45. So if I were to buy PRWCX at the intial minimum after 1 year my total cost for PRWCX equal an ER fee of ($177.50) + a TF fee of ($45) or a total of ($222.50). The NTF version, PLCAX, would cost ($255), a difference of $33.50 in favor of PRWCX.
Totals after: Year 2: PRWCX ($400) vs. PLCAX ($510) a difference of $110.
These number don't take into account the drag an extra .31 ER has on the overall performance of PLCAX compared to its identical lower ER fund PRWCX.
I'm just curious, and I wonder what the nature of the NTF relationship is between a broker (for example, Schwab) and the underlying fund. Does a broker run one "master" account with the underlying fund, and then keep all of the individual accounting within the brokerage, or does the broker actually open an individual account for each customer with the underlying fund?
I use Schwab as the example because I happen to use them, but I wonder if there is some sort of "standard" arrangement between NTF brokers and the underlying funds?
Reply to @msf: Good digging msf. It bothered me because I did not understand difference between the NTF expense of 0.4% and the 12b-1 fee. On the call yesterday with the good folks at Oakseed, they stated the 12b-1 fee of 0.25% was the only ER difference between the investor shares SEEDX with NTF and institutional SEDEX. Checking with Schwab site, that rings true. They offer SEEDX with NTF at 1.41 and SEDEX at 1.16. The difference in ER being the 12b-1.
Reply to @bee: Many, many years ago I owned some Advisor class shares of a T. Rowe Price fund. It was with the brokerage arm of a major bank. The reason was that with a relatively small portfolio I could get bank fees waived. I did the same calculations as you. I figured that the extra investment cost per year was around $12-$15, and considered that an acceptable charge for the bank services.
Once the bank shut down its discount brokerage arm, I moved the shares to TRP, where they did a tax-free exchange into the lower cost Investor class shares.
I was going to respond with two words: omnibus account, and then link to a definition. (An omnibus account is one big bucket, as you've described a "master" account.) But in searching for definitions, I ran across this ICI publication, describing in gory detail all the possible intermediaries (brokers, banks, advisers, insurance companies, etc.), the different ways they can interact with the fund (your question), what services they provide, how they are compensated, etc.
According to the pub (see "Account Structures" in Section 1, pp.6-7), there are a couple of ways the arrangement between the broker (NTF or not) and the underlying funds can be structured.
One is the omnibus account, which you've described. The broker keeps all the details to itself, aggregates the transactions, and sends one order per day to the fund.
The other is an individual networked account, again largely as you've described. Except that the account is typically registered with the fund as FBO (for benefit of) the broker. The broker may or may not pass on any information about the true customer to the fund.
Finally, note that the ICI pub says the trend was toward omnibus accounts (this was as of 2009).
Hi there msf, and thanks for your reply, well researched and interesting as usual. I was just thinking that in the case of an omnibus account the broker really is entitled to a little something, as there is a definite "value added" component.
I realize from these conversations that there may be an element of unfairness to "direct" account holders, but I also feel that it is just impractical to need to have a separate direct account for each and every fund house (how many tons of "junk" mail does that generate?), and financially ruinous to have to pay a significant fee/load/expense/whatever to a brokerage for a series of fairly small purchases where one is gradually trying to DCA into a position.
If the funds are truly worried about the issue, presumably they are free to offer an in-house discount on their expenses to their direct-account holders. Or maybe send them a free toaster or a genuine Ginsu steak knife set.
When Schwab first came out with its supermarket, its spiel was that it would save the funds so much money by servicing the accounts (instead of the fund distributor doing that), that the savings would at least cover the fee they were charging the funds.
For small funds, where distribution costs eat up a larger percentage of AUM, this may have actually worked, initially. I believe Schwab originally charged "only" 0.25%. So for some funds, the supermarkets weren't costing their investors extra money.
But this only worked (if it worked at all) until the supermarkets started jacking up their fees. Now, it seems to cost every fund more to go through a supermarket than to service the accounts themselves. So perhaps they should offer those toasters to direct investors.
When Selected Shares tried out your idea (by offering a lower cost share class to direct investors), they were slammed not only by Schwab but by Fidelity. From Kiplinger, Jun 12, 2006:
Every once in a while, a fund firm bucks the system. Selected American Shares and Selected Special Shares, run by the Davis fund company, decided it wasn't fair to charge direct investors the same fees as those who used no-transaction-fee platforms. They launched "D" shares for direct investors, to go along with existing "S" shares, which would still be sold for no fee through brokers. The new D shares levy a lower expense ratio.
First Schwab and then Fidelity, the two biggest players in this arena, balked. Both refuse to offer Selected's S shares to new investors. They don't want investors saving money on the same funds by foregoing their no-transaction-fee platforms. Says a spokesperson for Schwab: "Mutual fund shares offered via OneSource [Schwab's fund program] must represent the lowest share class available anywhere, including when purchased directly from the fund company itself."
Reply to @msf: Wow. But the more I see, the worse it gets. Honestly, with amount of internet coverage today, I would think there would be more opportunity than ever for smaller funds to bypass NTF altogether and still attract AUM with direct deposit. A dream, I know...but a good dream!
Comments
David
Don't just blame the platforms. Take a look at what Appleseed has done.
Here's a diffmk'd copy of its 2008 prospectus, filed with the SEC:
http://www.sec.gov/Archives/edgar/data/1199046/000103544908000172/ust0308485b.htm
It shows that the fund added a 12b-1 fee (0.25%) to be effective April 2009, as M* implied. But what Appleseed did subsequently was hide that fee instead. In the March 30, 2009 prospectus Appleseed didn't add a 12b-1 fee. Instead it buried this fee in "other expenses".
It had been capping fees at 0.90%. To enable this additional 0.25% "other expense" to be collected, it had to raise the cap accordingly. But Appleseed didn't just raise its cap to 1.15% (i.e. add in the 0.25%), it raised the cap all the way to 1.24%.
So not only did Appleseed hide the fee (not show it on the 12b-1 line), it raised the fee even higher (by weakening its fee waiver).
Maybe this amount of information hiding was over the top, even for the SEC. Or maybe the regulations changed. Because in the current prospectus, there's verbiage about being charged a 0.25% Administrative Services fee. That fee is still buried within "other expenses" (there's no other line item that could contain it).
To Charles' point about all investors (even ones investing directly) losing - it's a matter of perspective. I prefer to say that there is a cost of going through an intermediary, and those who are doing so are actually winners, since part of their cost is being subsidized by those who invest directly.
Of course, Charles is right that the NTF system costs all investors money, and in that sense, all investors in an NTF fund (whether via supermarket or directly) are losers.
You might be surprised to know that we have some clients who object to paying a $25 transaction fee for a $25,000-100,000 purchase of a non-NTF fund. It takes some explaining that they are ahead of the game almost immediately, and even then, they still look at an NTF purchase as a 'freebie'. But as several MFO posters have already pointed out, this is not the case. NTF is the price investors pay to consolidate their holdings with one custodian instead of dealing with each fund company separately.
For sure those folks who have self-directed brokerage 401k accounts are glad to have NTF options, since smaller investment amounts would be devastated by ticket charges.
In addition to your points Bob (and others). TF funds can be dollar cost averaged into (and out of) with no additional TF fees. One strategy I have used is to set up monthly sales of one fund and then I use these proceeds to buy additional sharesanother TF fund a few days later. It helps me reallocate and rebalance my portfolio with two very good TF funds that have lower ER than their NTF comparative share class. In some cases, only the TF fund is available at my brokerage...funds from Faiholme, Dodge and Cox, Wasatch, Franklin Templeton, and many smaller firms that choose not to offer their funds NFT.
Here's the math using two identical funds from T Rowe Price at my brokerage (not all brokerage fees are the same):
PRWCX (ER=.71) is sold TF using my brokerage while the advisor shares is offered NTF PLCAX (ER=1.02). The ER differential between the two funds is .31 or $31 per $1,000. The intial minimum for both funds is $2,500.
The transaction fee is $45. So if I were to buy PRWCX at the intial minimum after 1 year my total cost for PRWCX equal an ER fee of ($177.50) + a TF fee of ($45) or a total of ($222.50). The NTF version, PLCAX, would cost ($255), a difference of $33.50 in favor of PRWCX.
Totals after:
Year 2: PRWCX ($400) vs. PLCAX ($510) a difference of $110.
These number don't take into account the drag an extra .31 ER has on the overall performance of PLCAX compared to its identical lower ER fund PRWCX.
I use Schwab as the example because I happen to use them, but I wonder if there is some sort of "standard" arrangement between NTF brokers and the underlying funds?
Once the bank shut down its discount brokerage arm, I moved the shares to TRP, where they did a tax-free exchange into the lower cost Investor class shares.
I was going to respond with two words: omnibus account, and then link to a definition. (An omnibus account is one big bucket, as you've described a "master" account.) But in searching for definitions, I ran across this ICI publication, describing in gory detail all the possible intermediaries (brokers, banks, advisers, insurance companies, etc.), the different ways they can interact with the fund (your question), what services they provide, how they are compensated, etc.
According to the pub (see "Account Structures" in Section 1, pp.6-7), there are a couple of ways the arrangement between the broker (NTF or not) and the underlying funds can be structured.
One is the omnibus account, which you've described. The broker keeps all the details to itself, aggregates the transactions, and sends one order per day to the fund.
The other is an individual networked account, again largely as you've described. Except that the account is typically registered with the fund as FBO (for benefit of) the broker. The broker may or may not pass on any information about the true customer to the fund.
Finally, note that the ICI pub says the trend was toward omnibus accounts (this was as of 2009).
I realize from these conversations that there may be an element of unfairness to "direct" account holders, but I also feel that it is just impractical to need to have a separate direct account for each and every fund house (how many tons of "junk" mail does that generate?), and financially ruinous to have to pay a significant fee/load/expense/whatever to a brokerage for a series of fairly small purchases where one is gradually trying to DCA into a position.
If the funds are truly worried about the issue, presumably they are free to offer an in-house discount on their expenses to their direct-account holders. Or maybe send them a free toaster or a genuine Ginsu steak knife set.
For small funds, where distribution costs eat up a larger percentage of AUM, this may have actually worked, initially. I believe Schwab originally charged "only" 0.25%. So for some funds, the supermarkets weren't costing their investors extra money.
But this only worked (if it worked at all) until the supermarkets started jacking up their fees. Now, it seems to cost every fund more to go through a supermarket than to service the accounts themselves. So perhaps they should offer those toasters to direct investors.
When Selected Shares tried out your idea (by offering a lower cost share class to direct investors), they were slammed not only by Schwab but by Fidelity. From Kiplinger, Jun 12, 2006: