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Rethinking Mutual Fund Pricing, Entirely

The SEC's acceptance of "clean shares" could usher in a simpler fund-pricing scheme.

John Rekenthaler, 01/18/2017

The One True Road? 
The past two columns have delved into the details of mutual fund pricing. Fascinating material, for those who like to view George Seurat paintings from 18 inches away.

This article, mercifully, stands further back. It considers an entirely different approach. Today, mutual funds price their share classes according to the needs of their distributors. If financial advisors want an annual 1% payout, create C shares with a 1.00% 12b-1 fee to meet their wishes. The new Department of Labor guidelines won’t permit the existing A shares? Invent T shares, priced to meet the distributors’ new requirement.

What if that scheme were to change? What if there were but a single share class for mutual funds, around which distributors add their prices? After all, that is what already occurs with stocks, bonds, and exchange-traded funds. Nobody creates one version of those securities to sell on Schwab’s No Transaction Fee platform, a second version to use with midsize 401(k) plans, and a third version for institutional use. The cost to purchase a bond is determined by the company that sells you that bond, not the issuer.

One mutual fund, one price. The fund would carry no upfront or exit fees, nor ongoing sales charges in the form of 12b-1 fees, nor embedded payments to transfer agents or record keepers. Its only costs would be for its ongoing management and operations, as reflected in its ongoing expense ratio. No multiple share classes, no asterisks. And those expense ratios would be at most equal to those of today's institutional share classes and in some cases even less than that.  

Then, the entity that sells the fund may charge what it wishes for its service, billed separately. That invoice might come as an annual fee or as a one-time commission. The form matters not. The critical thing is that mutual funds, as with stocks, bonds, and ETFs, would no longer collect revenues on behalf of other parties.

That sounds suspiciously simple. Surely, somebody must have thought of this idea before.

Legal Matters
Indeed they did. However, until now those who had such a vision have been blocked by an obscure passage, Section 22(d), in the Investment Company Act of 1940, which governs mutual fund sales. There is some debate about the intent of Section 22(d)’s authors but until now no question about its outcome: Fund pricing is to be established by the funds themselves, not by the firms that distribute them.

That is about to change. On Jan. 6 of this year, American Funds sent a so-called “no-action letter” to the SEC, titled “Request for interpretative guidance regarding Section 22(d) of the Investment Act of 1940.”

is vice president of research for Morningstar.

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