FYI: (This is a follow-up article)
Capital Group recently made its entire American Funds open-end lineup available commission-free on Fidelity and Schwab's brokerage platforms, providing greater access to one of the industry's flagship firms. Investors who have avoided the lineup may want to reconsider it. Indeed, the firm's competitive advantages run deep, especially in equities. Below is a select overview of the firm and lineup. It elucidates American Funds' key competitive advantages and areas for improvement.
Regards,
Ted
http://news.morningstar.com/articlenet/article.aspx?id=773741
Comments
Let's look at the other side of the coin (so-to-speak).
I am an AF shareholder that paid the "one time sales load" many years back before there were a good selection of no load funds. As I understand these no load (F1) shares are for wrap accounts where an ongoing account wrap fee is charged rather than a one time upfront sales load. In talking with my broker I was told I will be good to go (as in the past) with my self directed ira account which would be grandfarthered with no wrap fee charged. Now, I am thinking that is indeed a good deal. Although, I can not put new money into this account after April 2017 (retired now so that is not important to me) I will be allowed to do nav exchanges within fund families owned in this account. And, to, of course, sell fund shares and to take distributions as I have done in the past. Since, all of my funds within this account are set for their distributions to pay to cash, at this time, sales are not necessary. It is uncertain at this time if I can buy new shares with my fund distributions unless I set the account up before April 2017 for reinvestment of fund distributions. Since, I am retired I most likely will leave the funds distributions set to pay to cash. While, my son, who is still working, will leave his account set for reinvestment of fund distributions.
Also know, some American Funds A shares can be bought back of the 5.75% sales charge you reference.
I'm thinking I've got a good deal ... no ongoing wrap fee for me. From my perspective I've got the better deal over what new investors will be getting today who invest in F1 shares and have to pay ongoing wrap fees.
Skeet
But what does that mean? The load drops to the bottom line of the investment advisor or they get used for other expenses that are normally collected through 12b-1 fees, right? And 12b-1 fees are supposed to be used for sales and marketing, no? I guess, but its just a guess, that the fund company is better off in the long run with 12b-1 fees that "never" end as long as their results are good enough to avoid big redemptions. Maybe this is a play for market share with all the investors who simply won't pay a load as a matter of principle rather than any economic evaluation of the options.
As usual for M*, not only don't they mention the giant 12b-1 fees for the R1 class, they actually go so far as to talk about how American Funds' fees are low in almost all cases- for the load bearing shares of course and without considering the load I believe.
For example, here's the entry an F-1 fund at Scottrade:
https://research.scottrade.com/qnr/Public/MutualFunds/Summary?symbol=316326
At the top of the page it says:
(!) ABHFX is an Advisor Class fund, which is available to investors who are working with a Scottrade® Advisor Services Registered Investment Advisor.
There's where the wrap fee (or flat fee, or whatever) comes from. Not from the brokerage itself. The big news is that you don't have to work with an advisor to buy the same shares at Schwab or at Fidelity.
All funds have costs associated with maintaining accounts, such as producing annual statements for existing investors, answering their questions, etc. Ultimately it is the investor who pays these costs, but the mechanics can vary from fund to fund.
For example, American Century funds have a single "all in" fee. You pay the management company a flat fee, and they cover all the expenses. For Ultra Investor class shares TWCUX , that's 0.98%. Some of that is going to pay the actual managers, but a fair chunk is going to pay for servicing the accounts (or to pay the NTF platforms to service the accounts for them). Since servicing institutional accounts is cheaper (less to do per dollar in the account), the institutional shares TWUIX charge an "all in" fee of just 0.78%.
There's no 12b-1 fee there, there aren't even "other" fees. But you're still paying a percentage for the servicing and for the NTF platform.
Most funds don't use an "all in" fee schedule. They may bury the servicing costs in "other expenses". Or they may list a separate line item for servicing fees. Usually that shows up as a 12b-1 line item. Whether the cost is called out or not, it's there, and you're paying it.
What matters is not whether there are separate line items, but how much your total expenses are. TWCUX (0.98% ER) is not a better deal than TIIRX (0.73% ER) simply because it has no "other" expenses. TWCUX has just internalized those expensees and you're still paying for them. TWCUX is not a better deal than TIIRX because it doesn't have a separate 12b-1 fee. It has just internalized the servicing costs and you're still paying for them.
TIIRX is the better deal because it costs less "all in".
Where you are right is that 12b-1 fees above 0.25% must be used for marketing and sales, not for running the fund, for maintaining existing accounts. That's money that isn't being used to help you, the investor. And that's why funds with 12b-1 fees above 0.25% cannot be called noload funds.
R1 funds, with 1.00% 12b-1 fees are not no load funds. And they're not the share class discussed in the M* article. No. As explained above, a fund can market itself as a noload fund only if its 12b-1 fee does not exceed 0.25% and only if that fee is used for servicing accounts, not for sales and marketing. So the F-1 shares (0.25% 12b-1 fee) use the fee for servicing the accounts (i.e. they pay Fidelity and Schwab to service the accounts).
https://www.sec.gov/answers/mffees.htm They don't talk about the R1 class because they're writing about the F1 share class that retail investors can purchase noload without using an advisor. Matching fund against fund, AF vs. most other fund families, you'll find that AF funds, all in, are cheaper. Their A shares are cheaper than other load families' A shares, and their F-1 shares are cheaper than most families' noload shares, whether the family is a load family or a noload family.
I completely agree that certain expenses exist regardless of how they're packaged. Nonetheless I think many people are mislead by both lack of transparency on the part of fund companies, even though it has certainly gotten better over time, but also by companies like M* who provide historical returns and category rankings without regard for whether a fund carries a load or not and without disclosing that fact. For instance, AF New World A is ranked in the 18th percentile for its 10 year record but if you account for the load then it drops to the 30th percentile. I'm not saying 30th percentile is bad at all, just that they're leaving out an important fact. It's not an easy fact to deal with but it could at least be disclosed so people know the numbers they see don't tell the whole story.
That makes it problematical for comparative load-adjusted returns, since the loads themselves would vary all over the map depending upon the situation. Still, a footnote for the worst-case load would be of some help, and I definitely agree that front-load funds should be "on their way out": the competitive market conditions now are nothing like they were 20 or 30 years ago.
1) He'll periodically skim money from your account, let's say on a daily basis, or
2) He'll delegate that to the fund company that will then skim money from the fund on a daily basis and remit it to your advisor
I think you'd agree that your return is the same either way. Same tithing, same schedule, it's just the collection mechanism that's different.
Case (1) is a wrap account with F-2 shares and a 1% fee. Case (2) is a commission-based account with C shares (1% 12b-1 fee, for the sake of argument all going to the advisor).
One would probably expect the returns of those two classes of shares to be reported differently. Therein lies the problem. Your return is the same, the payment to your advisor is the same, and yet one class' returns are different from another, simply because of the payment mechanism.
What this suggests to me is that to the extent possible, one should keep the payment mechanism out of the return data. I want the performance figures to represent how well the portfolio did, not what I paid or didn't pay to my advisor.
We can keep the advisor fees (which as OJ noted can vary) out of the equation for A shares. Unfortunately, they're baked into the equation for B and C shares. Even worse, you've got the reverse problem with B shares - the performance figures understate actual performance. That's because B shares convert to cheaper A shares after some number of years, but the performance figures assume the same higher expenses ad infinitum.
The 30th percentile estimate is likely in error, though I haven't checked. I'm guessing that when you multiplied the ending value by 94.25% (i.e. reducing account by 5.75%), you did not do the same for all the other front end load funds. Their performance figures should have been reduced as well.
FWIW, M* does incorporate the impact of loads in its star ratings. That's why AMECX is 4*, but AMECX.lw is 5*.
In your example I certainly agree with your assessment that different returns don't necessarily mean you will do better or worse as an investor but if it's in a taxable account I think the taxes would be different too. In case 2 your entire return is captured as a capital gain or loss so you're going to get complete credit for what you've paid. In case 1 I believe the wrap account fee would be an itemized deduction that has to be bigger than 2% of your AGI to begin with and could be lost entirely if you don't itemize.
When funds skim money to pay for expenses, they first take that money first from interest, nonqualified divs, and possibly short term gains that would otherwise be distributed.
If it has enough ordinary income to cover the advisor payments, then what happens is simply that your ordinary income divs are reduced by the amount of the payments. That's equivalent to a straight deduction against ordinary income. The NAV would not be affected by paying this additional cost.
For example, if there's $5 of interest income/share available and the fund pays your advisor $4, then it distributes $1 of ordinary divs and the NAV drops $5. If it doesn't pay your advisor (case 1) then it distributes $5 of ordinary income to you, the NAV still drops by $5.
If the fund reduces its cap gains distributions (rather than its ordinary income distributions) to pay the advisor, then again the NAV is unaffected but now you'll see your cap gains income (as opposed to ordinary income) reduced by the advisor fees. A less valuable income reduction.
The NAV would be affected in the way you described only if the fund had to use assets that it would not otherwise have distributed. That is, if the portfolio did not generate enough income (via interest, divs, net gains), to cover costs, then the fund would have to use actual share value to pay the advisor.
If the NAV were reduced (or its increase diminished), you would indeed be able to capture the expense as a capital loss (or reduced gain). This is a less valuable loss than the two above - first because its is a capital loss vs. a reduction of ordinary income, and second because you'll only recognize it when you ultimately sell your shares vs. a reduced distribution that is recognized now.
So the tax impact in case (2) is quite variable, in both nominal value (ordinary income vs. cap gains) and present value (available in current tax year or only when shares sold).
You are correct about the 2% AGI floor, so the value depends in part on what other misc. deductions you had (e.g. tax prep fees), and whether you are even itemizing.
Thanks for the discussion! I learned a few things about the details of how fund companies deal with things and that's much appreciated.