No load fund compensation

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optimist's picture
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How do actively managed no load fund companies get compensated? If I were a retail investor and bought a no load fund from someone like Oakmark, how do they get paid? Is it just through volume? I realize some no load funds have higher 12b-1 fees, but some have very low fees.

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B24
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optimist wrote: How do actively managed no load fund companies get compensated? If I were a retail investor and bought a no load fund from someone like Oakmark, how do they get paid? Is it just through volume? I realize some no load funds have higher 12b-1 fees, but some have very low fees.

Are you serious? PLEASE tell me you don't work in this industry.

I am going to ASSUME you are a retail investor and stumbled upon this site...so I will humor you:
All mutual fund companies make money managing their mutual funds. So for example, for a fund with a 0.65% expense ratio, that might include a 0.25% management fee (their compensation), plus 0.40% in marketing fees and administrative expenses (operating expenses, subadvisor fees, etc.).

optimist's picture
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Thank you for humoring me. So, assuming two funds share the same objectives, risks, performance, etc., why would I choose an A share fund over a no load?

Sportsfreakbob's picture
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Joined: 2008-08-24

He's definately a retail investor

LSUAlum's picture
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optimist wrote:Thank you for humoring me. So, assuming two funds share the same objectives, risks, performance, etc., why would I choose an A share fund over a no load?

Here's how I explain it to clients that ask the same questions.
 
Actively managed funds and No Load funds are not the same typically.
 
1st, Most No loads are not actively managed so their capture rate differs from an Actively Managed fund. By capture rate I mean if the market goes up 50% and the fund goes up 40% it has an 80% capture rate on the upside. If the market goes down 50% and the fund goes down 30% it has a 60% capture rate on the down side. The theory being that actively managed funds can give you a better 'RISK ADJUSTED RETURN' than non actively managed.
 
2nd, Most Actively Managed NO load funds have higher expense ratios than a similar A share fund.  This is because the managers get paid to manage the fund and in order to have similar compensation the NO load has higher expenses per year than a fund that receives the compensation up front.  This means that if you want to move money from fund to fund (not same fund family) A shares will eat you up, but if you stick with one fund family you will SAVE money over time in an A share versus an Actively Manged No Load.
 
3rd, If the fund is Actively Managed, and has lower expense ratios than a similar fund AND aligns with your investment goals, there are times when it is the better option. However, you run the risk of 'Brain Drain' by paying the fund manager who is doing a great job less money than he could make at a different company. So, continuity of Fund Managers could be a concern.
 
So in conclusion, if you are comparing Actively Managed No-Load vs. A share, with a 5+ year time horizon you'll usually do better with the A share. However, if you are comparing Passively Managed No Loads with Actively Managed A shares, you'll have to consider what the capture rates are. Risk Adjusted Return is, IMHO, the reason to have an advisor versus doing it on your own.
 
Comprehension of Risk Adjusted Return is the reason those with money have professionals manage their money and why those DIY'ers without money don't get it and watch Suze Orman.

Ron 14's picture
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Ferris Bueller wrote: optimist wrote: Thank you for humoring me. So, assuming two funds share the same objectives, risks, performance, etc., why would I choose an A share fund over a no load? Go call your Schwab/Fidelity 1-800 number and talk to your broker of the hour for that. God I hate do it yourself investors trying to save a buck.
 

ChrisVarick's picture
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Does anyone even use A shares for accounts under $250k anymore?

chief123's picture
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LSUAlum wrote:optimist wrote:Thank you for humoring me. So, assuming two funds share the same objectives, risks, performance, etc., why would I choose an A share fund over a no load?

Here's how I explain it to clients that ask the same questions.
 
Actively managed funds and No Load funds are not the same typically.
 
1st, Most No loads are not actively managed so their capture rate differs from an Actively Managed fund. By capture rate I mean if the market goes up 50% and the fund goes up 40% it has an 80% capture rate on the upside. If the market goes down 50% and the fund goes down 30% it has a 60% capture rate on the down side. The theory being that actively managed funds can give you a better 'RISK ADJUSTED RETURN' than non actively managed.
 
2nd, Most Actively Managed NO load funds have higher expense ratios than a similar A share fund.  This is because the managers get paid to manage the fund and in order to have similar compensation the NO load has higher expenses per year than a fund that receives the compensation up front.  This means that if you want to move money from fund to fund (not same fund family) A shares will eat you up, but if you stick with one fund family you will SAVE money over time in an A share versus an Actively Manged No Load.
 
3rd, If the fund is Actively Managed, and has lower expense ratios than a similar fund AND aligns with your investment goals, there are times when it is the better option. However, you run the risk of 'Brain Drain' by paying the fund manager who is doing a great job less money than he could make at a different company. So, continuity of Fund Managers could be a concern.
 
So in conclusion, if you are comparing Actively Managed No-Load vs. A share, with a 5+ year time horizon you'll usually do better with the A share. However, if you are comparing Passively Managed No Loads with Actively Managed A shares, you'll have to consider what the capture rates are. Risk Adjusted Return is, IMHO, the reason to have an advisor versus doing it on your own.
 
Comprehension of Risk Adjusted Return is the reason those with money have professionals manage their money and why those DIY'ers without money don't get it and watch Suze Orman.
 
I disagree there are plenty of actively managed funds that cost less than A shares funds.

ChrisVarick's picture
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Chief,
I agree, there are some no-load funds that are lower in operating expenses than A share funds. What do you say to clients that want to use no-load funds?

chief123's picture
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ChrisVarick wrote:
Chief,
I agree, there are some no-load funds that are lower in operating expenses than A share funds. What do you say to clients that want to use no-load funds?
 
I say no problem.. I actually use a couple for clients under $75K(mostly referrals).
 
Other than that I use ETFS

LSUAlum's picture
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iceco1d wrote: LSUAlum wrote:optimist wrote:Thank you for humoring me. So, assuming two funds share the same objectives, risks, performance, etc., why would I choose an A share fund over a no load?

Here's how I explain it to clients that ask the same questions.
 
Actively managed funds and No Load funds are not the same typically.
 
1st, Most No loads are not actively managed so their capture rate differs from an Actively Managed fund. By capture rate I mean if the market goes up 50% and the fund goes up 40% it has an 80% capture rate on the upside. If the market goes down 50% and the fund goes down 30% it has a 60% capture rate on the down side. The theory being that actively managed funds can give you a better 'RISK ADJUSTED RETURN' than non actively managed.
 
2nd, Most Actively Managed NO load funds have higher expense ratios than a similar A share fund.  This is because the managers get paid to manage the fund and in order to have similar compensation the NO load has higher expenses per year than a fund that receives the compensation up front.  This means that if you want to move money from fund to fund (not same fund family) A shares will eat you up, but if you stick with one fund family you will SAVE money over time in an A share versus an Actively Manged No Load.
 
3rd, If the fund is Actively Managed, and has lower expense ratios than a similar fund AND aligns with your investment goals, there are times when it is the better option. However, you run the risk of 'Brain Drain' by paying the fund manager who is doing a great job less money than he could make at a different company. So, continuity of Fund Managers could be a concern.
 
So in conclusion, if you are comparing Actively Managed No-Load vs. A share, with a 5+ year time horizon you'll usually do better with the A share. However, if you are comparing Passively Managed No Loads with Actively Managed A shares, you'll have to consider what the capture rates are. Risk Adjusted Return is, IMHO, the reason to have an advisor versus doing it on your own.
 
Comprehension of Risk Adjusted Return is the reason those with money have professionals manage their money and why those DIY'ers without money don't get it and watch Suze Orman.You usually have some decent insight on economics, and the industry.  This just isn't one of those times.  The "load" or lack thereof, has nothing to do with the management of the fund.  The fund managers, the fund company, makes their money from the expense ratio (specifically, the management fee).  No load funds simply don't wish to be distributed by brokers that do commission business.  They want to be distributed directly, or via a RIA. 

Not entirely true. First, A shares do not distribute 100% of the 'load' to the B/D. Typically .75 - .50 is kept by the Fund Company for purchases under $1mm. Notice above I mentioned that the expense ratios of actively managed for passively managed funds. You are correct, I did not break out the 'management fee' portion of the expense ratio specifically. However, you can compare industry averages for expense ratios given a funds morningstar 'box' and you can see that actively managed no load funds typically have higher expense (And thus management) fees. 
 
Also, bear in mind, that my post was directed to the (and I believe he was not asking earnestly but pretending to be a rep but that is another discussion) notion of 'how do you explain to a client why you would ever want to invest in 'A' shares versus a no load.'
 
Regardless of how or why a fund choses it's distribution routes (no load versus b/d distribution) the end comparison that matters to me is the capture rate and the expense ratio. No-load is very often not the least expensive route.
 
If a client truely wanted 'least expensive' they would buy institutional shares of 'load fund companies' through a fee only arrangement through ML, MSSB, UBS, EJ or whomever. Paying an RIA a % of AUM while then buying a No-Load vanguard fund with a high capture rate on the downside amuses me. But then, that's a discussion on your feelings on Asset Allocation and if you are Boglehead or not...again a different discussion altogether.

B24's picture
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Couple things:
 
Buy A-shares if there is a fund(s) that you truly cannot find less-expensive as a no-load.  Although I would say most funds either have some sort of no-load equivalent, or you could easily find something similar (or just as good) without the load. 
 
Also, typically you are buying load funds because you want the service that goes along with it from an advisor.  If you are just being handed load funds, and paying a big load, but not getting service, then it's not worth it.

LSUAlum's picture
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chief123 wrote:LSUAlum wrote:optimist wrote:Thank you for humoring me. So, assuming two funds share the same objectives, risks, performance, etc., why would I choose an A share fund over a no load?

Here's how I explain it to clients that ask the same questions.
 
Actively managed funds and No Load funds are not the same typically.
 
1st, Most No loads are not actively managed so their capture rate differs from an Actively Managed fund. By capture rate I mean if the market goes up 50% and the fund goes up 40% it has an 80% capture rate on the upside. If the market goes down 50% and the fund goes down 30% it has a 60% capture rate on the down side. The theory being that actively managed funds can give you a better 'RISK ADJUSTED RETURN' than non actively managed.
 
2nd, Most Actively Managed NO load funds have higher expense ratios than a similar A share fund.  This is because the managers get paid to manage the fund and in order to have similar compensation the NO load has higher expenses per year than a fund that receives the compensation up front.  This means that if you want to move money from fund to fund (not same fund family) A shares will eat you up, but if you stick with one fund family you will SAVE money over time in an A share versus an Actively Manged No Load.
 
3rd, If the fund is Actively Managed, and has lower expense ratios than a similar fund AND aligns with your investment goals, there are times when it is the better option. However, you run the risk of 'Brain Drain' by paying the fund manager who is doing a great job less money than he could make at a different company. So, continuity of Fund Managers could be a concern.
 
So in conclusion, if you are comparing Actively Managed No-Load vs. A share, with a 5+ year time horizon you'll usually do better with the A share. However, if you are comparing Passively Managed No Loads with Actively Managed A shares, you'll have to consider what the capture rates are. Risk Adjusted Return is, IMHO, the reason to have an advisor versus doing it on your own.
 
Comprehension of Risk Adjusted Return is the reason those with money have professionals manage their money and why those DIY'ers without money don't get it and watch Suze Orman.
 
I disagree there are plenty of actively managed funds that cost less than A shares funds.

With over 8,000 funds available in 2008 I'm talking about generalities. There are plenty of actively managed A share funds that have lower expense ratios than No-Load funds also. It's about generalities.
 
We've all seen the fund that looks ok on the surface but has a rediculous expense ratio that makes it not worth buying/selling.

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This opinion would not be popular with the writers at Money or Fortune or mostly any other financial columnist (that has never done anything in the investment world), but I feel sometimes too much emphasis is placed on expense ratios.  A share loads aside, unless you are comparing two similar funds (like a large cap value fund), you really have to look at the performance and consistency of performance.  I'll give an example....
Although they are not identical, would you rather buy/recommend Bond Fund of America at 0.67%, or PIMCO Total Return at 1.1%?
There are MANY examples like this.  Now, if you are just looking for index or index-like funds, then obviously expenses are critical.  But I am not going to disregard a stellar fund/manager because it's expense ratio is 25-50 bips higher than another.  Most of the funds I use have moderate expense ratios....not real high, but not dirt-cheap.  Other than maybe some emerging markets or other niche funds, I would not exceed 1.25% or so.
 
I do think that smaller fund companies have challenges being competitive sometimes unless they are very good.  For example, I don't know how Hartford can do it.  High expenses, average performance at best (although I love Hartford Cap App).  I take that back....I know how they do it.   Grrrrrr....
 
Most good, consistent funds have lower expense ratios because their asset base is higher.  Look at Ivy Asset Strategy.  Intuitively, you would think their expenses would be high because they require a lot of research, hedging strategies, multiple asset class strategies, likely higher than normal trading costs.  But because of the asset base, they can keep the expenses down around 1.00%.
 
I'm babbling.  But the point is, sometimes expenses can be over-emphasized if you believe in active management.

LSUAlum's picture
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B24 wrote:This opinion would not be popular with the writers at Money or Fortune or mostly any other financial columnist (that has never done anything in the investment world), but I feel sometimes too much emphasis is placed on expense ratios.  A share loads aside, unless you are comparing two similar funds (like a large cap value fund), you really have to look at the performance and consistency of performance.  I'll give an example....
Although they are not identical, would you rather buy/recommend Bond Fund of America at 0.67%, or PIMCO Total Return at 1.1%?
There are MANY examples like this.  Now, if you are just looking for index or index-like funds, then obviously expenses are critical.  But I am not going to disregard a stellar fund/manager because it's expense ratio is 25-50 bips higher than another.  Most of the funds I use have moderate expense ratios....not real high, but not dirt-cheap.  Other than maybe some emerging markets or other niche funds, I would not exceed 1.25% or so.
 
I do think that smaller fund companies have challenges being competitive sometimes unless they are very good.  For example, I don't know how Hartford can do it.  High expenses, average performance at best (although I love Hartford Cap App).  I take that back....I know how they do it.   Grrrrrr....
 
Most good, consistent funds have lower expense ratios because their asset base is higher.  Look at Ivy Asset Strategy.  Intuitively, you would think their expenses would be high because they require a lot of research, hedging strategies, multiple asset class strategies, likely higher than normal trading costs.  But because of the asset base, they can keep the expenses down around 1.00%.
 
I'm babbling.  But the point is, sometimes expenses can be over-emphasized if you believe in active management.

I agree with what you are saying. I'm commenting on expenses AND capture rates. Neither by itself is a the determining factor. You have to compare them together.
 
Risk Adjusted Return is what I'm going for and they work in tandem.

optimist's picture
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LSUAlum, thank you for your response. I asked the question, albeit maybe not with the best choice of words, to see how other professionals respond when handed the same question from prospects and DYIers. For the record, I am a Rep and fully aware of how 12b-1 fees are composed, how active and passive funds are different, and how both types can be beneficial for clients.
After reading this forum for some time, I finally asked a simple question that many of us get to stimulate a varied response. I should have known the first responses would have been from those apearing to be threatened by retail investors. I learned long ago to never make assumptions about people. I wish more people would do the same.

army13A's picture
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LSUAlum wrote:

 
1st, Most No loads are not actively managed. Where do you get this from? Fidelity's entire portfolio mix is actively managed except for the couple of index funds they have. 
 
2nd, Most Actively Managed NO load funds have higher expense ratios than a similar A share fund.  Where are you getting your information from? To say that most no load funds have higher ER's than load funds is crazy.  There is no correlation between the two.  Some no loads suck, some load funds suck, some no loads have higher ER, some loads have higher ER's.  This is how I explain the load vs no load to a DIY investor.  I pull out a financial calculator and get it ready to enter some digits.  I tell them that for a load fund to outperform a no load fund in the long term, all it has to do it outperform by 1% for the load to be indifferent.  So I tell them that they picked out mutual fund xyz by reading morningstar, money magazine (I snicker when I say money), compared beta, standard deviation, expense ratios, fund managers, etc and finally picked out a mutual fund they "thought" was a good fund.  They have their buddy who is a client of mine who told me to pick out an investment and I pick out a similar investment with similar expense ratios.  Their fund does 8% for the next 20 years; my fund does 9% for the next 20 years.  My client does better than they do with the load and they didn't waste their time researching.  Then I say all I have to do is outperform you by 1%.  I have analysts on my team; who do you have on yours? Suze Orman? With the math, it works every time but you have to do it over the long term, 15 years and beyond and the sales charge is irrelevant. 
 

chief123's picture
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AGEMAN wrote:ChrisVarick wrote:
Chief,
I agree, there are some no-load funds that are lower in operating expenses than A share funds. What do you say to clients that want to use no-load funds?
I would tell them I can do no-load funds and institutional shares in a fee based account.  If they don't think my advice is worth 1-1.25% then they should go direct with Vanguard or Fidelity. 

ditto

newnew's picture
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Yup; the fee is only an issue in the absence of value. this is the beauty of fee-based. it is transparent and it is pay as you go. that is why over 60% of ALL active mfds are now sold LOADWAIVED or NO LOAD. As it should be. Me, I prefer ETFs.

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