C-Shares go the way of the Do-Do Bird
62 RepliesJump to last post
A change in ways to sell funds
Congress didn't actually vote to end the confusion over mutual fund share classes this month, but they took a step that ultimately could go a long way to simplifying the way investors buy and sell fund shares.The House Financial Services Committee passed the Investor Protection Act of 2009, which has some major provisions concerning the way some financial planners - notably those affiliated with brokers - deal with customers. The offshoot of this bill - if it passes and is taken to its logical conclusion - could end share-class confusion by killing off C-class shares.
Overall, it's a major change in the way funds are bought and sold through advisers.
To see how this could happen in a bill that has nothing directly to do with mutual funds, join me on a round-about journey that starts with financial planners and brokers, and that ends with unintended improvement for fund investors.
The whole thing starts with one of the dirty little secrets in the financial advice world, namely that some people you trust for advice may not have your best interests at heart. Brokers - in fact any type of intermediary whose primary job is selling products - live by the standard of "suitability," meaning that the investments they select and sell to clients must be suitable for the buyer. No speculative penny stocks for elderly widows, for example; whatever they sell, they must believe that the investment is appropriate for the investment and the situation.
By comparison, an investment adviser - anyone who makes their money giving advice, rather than selling products - must live by a "fiduciary standard," meaning they have a responsibility to put your best interests ahead of their own. If it's not in your best interests, selling it - even if it's suitable and appropriate - they shouldn't do it.
Where things have gotten confusing over the years is that there are plenty of people who, technically, are brokers, working for one of the name-brand brokerage houses, but who function as financial planners or advisers. They may act like they are selling advice, but the legal standard that applies to them is suitability.
The result has been years of confusion and arguments in the financial advice business; brokerage firms felt like it was in their best interests to create a class of counselor who could compete with the emerging horde of financial planners, they just didn't think it was in their best interests to put the customer's interests first.
The Investor Protection Act would change that by requiring that brokers who act like planners - who sell advice, and not just products - live up to the fiduciary standard.
It's a major step forward for consumers, and while there will be a lot of debate on this portion of the act as it goes upstream from committee, most observers believe the fiduciary standard ultimately will be applied to everyone who sells advice.
That being the case, let's look at how advisers currently sell funds. A growing number of them simply use no-load funds, meaning issues that have no sales charges; instead of getting a commission, they charge a percentage of the assets they manage, typically in the neighborhood of 1 percent.
But broker-sold funds have, for years, mostly come in three varieties. Class A shares charge a front-end sales load; typically anywhere from 3 percent to 5.75 percent comes off the top and goes to pay the adviser. Class B shares have a back-end load, and they charge higher on-going expenses over the first few years of ownership; after four to six years, the out-the-door fee is removed and the higher costs, which pay for the adviser, shrink or the shares convert into A-class shares. Several big fund firms, most notably Franklin Templeton, have backed away from B shares in recent years, because they're typically not cost effective, raising questions about their "suitability."
Class C shares have no front- or back-end load, but charge a higher expense ratio for life. As a general rule, that means they are the most costly shares for long-term investors. Still, they are popular with advisers and consumers because they feel like no-load funds by avoiding all sales charges.
But popular doesn't mean "in the customer's best interests." Higher costs reduce long-term returns, plain and simple. If the fiduciary standard is applied across all types of advisers, the only way most experts believe an adviser could sell a C share is if they believe the client has a short holding period, or if the customer is a trader.
Brokerage firms, which backed away from B shares because they feared bad results in arbitration, are likely to now start backing away from C shares too.
"This should give rise to the end of the C share, and the whole concept of loads is going away too; any loaded funds will become more the exception than the norm," said Geoff Bobroff of Bobroff Consulting in East Greenwich, R.I. "The industry has quietly been moving toward paying all advisers - planners, brokers, whatever you call them - a percentage of assets under management. This will just speed that up."
I have to say that this whole mess is disapointing. If the industry goes to all fee based (which I doubt), that will not serve as "protection" for the investor.
Either the author of that article is trying to cause concern for the industry, and force them to action against this legislation, or the legislation will have collateral damage.I have felt from the beginning that legislating away commissioned-based products is harmful to the client, not the advisor. We will continue to do business. However, smaller clients become less appealing in an advisory-centric world. Therefore, small clients (who need the help arguably the most) will be shunned. However, there are firms popping up that are focusing on the small client (like under $250K) as a niche. But these are few and far between, and the service model is tough. IMHO, they need to find ways to make commissions more transparent, not go away.
In one breath they say C shares are not appropriate for most long-term clients, and in the other breath, they say advisory accounts are better, which will generally cost more over time than C shares. Makes no sense.Good article. Thanks B24. I agree with your assessment about making commissions more transparent.
Getting rid of load funds and migrating to fee based benefits firms. No more revenue volatilty from ups and downs of transactional business. Fees hit the bottom line each quarter. Hasn't this been the trend of the industry for the past 20-25yrs ? Big firms and their shareholders want consistent revenue streams. Now that banks own most of the big brokerage firms, guess what they want fee revenue instead of transactional revenue because it more closely resembles their existing business model.
The billing model works fine for smaller accounts. If done correctly, this can raise the quality of advice you get. Much like a law firm.
Junior advisor runs small accounts and bills out at I don’t know, $500/yr. Give him a 100 clients, and he’s making a pretty good living doing what? Rebalancing?
A tiered structure could be worked in.
The senior advisors have larger accounts and work off of a percentage of AUM model (or a higher fee structure).
Common practice in law firms. Associates bill at $150/hr, Junior partners at $300 and Senior partners at $450 or more (example).
And so on and so forth. Junior advisor wins, because he is getting clients and earning his stripes. Junior advisor’s clients win because they are getting competent advice at a lower cost.
Senior advisor wins because he’s getting paid more. Senior advisor’s clients win, they are getting a more experience advisor.
MO, that’s true assuming that your firm wants to have a “small-client” model in place. Most firms basically say why? 100 clients at $500/pop is $50K gross. After giving some to the firm and covering some overhead, there’s not much left. Yes, the model could work, but in reality it’s not a real easy model to implement. What about the 25 year-old that has $10K and wants to start DCA’ing in every month, What are you gonna make off that? $100?
Problem is, the fee model sort of lends itself to "service". What about the person that owns $250K of stocks, but doesn't want to go through a self-service firm (i.e. Scottrade, TDA, etc.), and they never intend to buy or sell anything? A broker can largely ignore them, but why would they want to pay an AUM fee? Sure, you could negotiate an annual "fee" which is small, but how many firms want to do that? I just think there will always be those clients that are better served by commissions than fees. For the record, I prefer fees models, but I can see those clients that prefer it the other way.Depends what they decide on. If they legislate them away, my guess is existing C-shares are grandfathered (like MFD firms that eliminated B shares). If they just legislate improved disclosures (like breaking out 12b-1's on statements), then all existing C shares would likely be impacted. Chances are, it will be something different and I'll be completely wrong.What will happen to existing C-Share holdings ?
[quote=B24]MO, that’s true assuming that your firm wants to have a “small-client” model in place. Most firms basically say why? 100 clients at $500/pop is $50K gross. After giving some to the firm and covering some overhead, there’s not much left. Yes, the model could work, but in reality it’s not a real easy model to implement. What about the 25 year-old that has $10K and wants to start DCA’ing in every month, What are you gonna make off that? $100?
Problem is, the fee model sort of lends itself to "service". What about the person that owns $250K of stocks, but doesn't want to go through a self-service firm (i.e. Scottrade, TDA, etc.), and they never intend to buy or sell anything? A broker can largely ignore them, but why would they want to pay an AUM fee? Sure, you could negotiate an annual "fee" which is small, but how many firms want to do that? I just think there will always be those clients that are better served by commissions than fees. For the record, I prefer fees models, but I can see those clients that prefer it the other way. [/quote]You have to set an account minimum for that. I understand what you are saying, I'm just saying if you structured your business correctly (and you already had a comfortable revenue stream, like most large firms) it could be done.
Think about how many advisors fail out of the business, but maybe wouldn't necessarily fail out if they were allowed to focus on smaller potatoes as they gain experience. Think of the money saved in training costs.
How much does Jones spend on training each year? MSSB, Merril?
Personally, I think Jones could implement an apprentice/master advisor program where they operated two offices two or three person offices like this.
I can't image they'd could do much more than stop future sales and existing funds remain like what is happening with companies that have dropped B shares. It wouldn't suprise me if in they just moved to A share or fee based only. Plain and simple. A-share, fee based, or go to vangaurd. I cannot see how they ever could eliminate pure commission based accounts all together. There are just to many issues with ALL brokerage accounts being fee based; regardless of size. There has been an enormous increase in disclosure amoung most all investments the past 5 years. Mainly variable annuities, fixed annuities, or private placements; but also mutual funds or prospectous items being reallocated.What will happen to existing C-Share holdings ?
Generally, I suspect that more regulation is not the answer. Small clients ( servicing small clients with C shares) will go the way of the dow dow bird (Oops, Uncle Sam much of the Dow now?).
Make that, dead corn ( I have provided a cheap cartoon to explain myself). http://www.milyunair.com/ Anway, you can just make a minimum of 25 or fifty thousand, and charge small clients more. Once again, the little guy loses. Like the guy at the tire place told me when I asked them about the tariff on Chinese tires, he said, " We're already getting those from someplace else. Those are mainly for the people on a budget, anyway. " Getting rid of C shares mainly makes it harder for some of us to give away some of our time to some less fortunate people.[quote=B24]I have felt from the beginning that legislating away commissioned-based products is harmful to the client, not the advisor. We will continue to do business. However, smaller clients become less appealing in an advisory-centric world. Therefore, small clients (who need the help arguably the most) will be shunned. However, there are firms popping up that are focusing on the small client (like under $250K) as a niche. But these are few and far between, and the service model is tough. IMHO, they need to find ways to make commissions more transparent, not go away.
In one breath they say C shares are not appropriate for most long-term clients, and in the other breath, they say advisory accounts are better, which will generally cost more over time than C shares. Makes no sense.[/quote] I think the argument isn't over C shares vs A shares, but fiduciary responsibility. The C share is basically a fiduciary payout and investment without the fiduciary. So i understand if they believe that brokers should not be paid on an ongoing basis for something that is "sold". I think EDJ will love this. They decrease payouts on C shares/B Shares. The have a fee platform now.. People with less than $50K, will be forced to pay A shares or go to Vanguard and right fully so. There is no reason for accounts under $100K to pay an advisor.[quote=Squash1][quote=B24]I have felt from the beginning that legislating away commissioned-based products is harmful to the client, not the advisor. We will continue to do business. However, smaller clients become less appealing in an advisory-centric world. Therefore, small clients (who need the help arguably the most) will be shunned. However, there are firms popping up that are focusing on the small client (like under $250K) as a niche. But these are few and far between, and the service model is tough. IMHO, they need to find ways to make commissions more transparent, not go away.
In one breath they say C shares are not appropriate for most long-term clients, and in the other breath, they say advisory accounts are better, which will generally cost more over time than C shares. Makes no sense.[/quote] I think the argument isn't over C shares vs A shares, but fiduciary responsibility. The C share is basically a fiduciary payout and investment without the fiduciary. So i understand if they believe that brokers should not be paid on an ongoing basis for something that is "sold". I think EDJ will love this. They decrease payouts on C shares/B Shares. The have a fee platform now.. People with less than $50K, will be forced to pay A shares or go to Vanguard and right fully so. There is no reason for accounts under $100K to pay an advisor. [/quote] When I started in this business I would have thought that comment was nuts, but really it is the truth.There is no reason for accounts under $100K to pay an advisor.
While I agree with this in theory, in practice it is false IMO. I have many clients that have $50m with me and $500m in their 401k. At the end of the day I am managing $550m for the client while getting paid on $50m. If you stop paying on these accounts, broker will ignore them and when rollover time comes, a broker won't get the business.Yes. That is a different case because the potential outweighs the short term work you are technically doing for free.
Jeb, this is true in that case. I have several clietns like that as well. I think what Squash is referring to is the 65 year-old that you are managing their last 50K for. That’s not a nest-egg, that’s a savings account. That’s the client you took while you were building your business. I still have a handful of them, and it is painful to talk to them. Yes, some of them are nice people, but more often than not, it’s like calling your aunt Alice just to see how she’s doing. And yes, a couple of those might give you referrals…but…
But you are right Jeb, there are some exceptions to the rule.So with more financial regulation, are they also going to take away the publics choice to (or not) buy points on a mortgage up front if you plan to stay in the home a long time? your really just buying down your interest rate when you buy a point or more which is the same as paying a load on an A share and getting lower expenses from day 1. Seems rediculous they would not address this since the faulty mortgages are to blame for the financial mess that we are in and not full disclosure between A & C shares.
IMO a client with 60k with me should pay the same loads/fee %'s/ commissons as someone with 110k. What makes my advice any less valuable to someone with a smaller account?
Wow, Interesting article that you have been posting here. I want read your other article. Could you plz provide me some articles.