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T Shares Are Best for Some Investors

Investors with smaller accounts who buy funds, stash them away, and then largely forget about them will be served well by T shares. 

John Rekenthaler, 01/13/2017

There’s a Catch (or Two)
As discussed in last Friday’s column, the T share class of mutual funds is coming to market. Invented after the Department of Labor issued its “Conflict of Interest” rule in spring 2016, the T share carries a maximum front-end sales charge of 2.5% and an ongoing 12b-1 fee of 0.25%. As Morningstar expects that all funds with an A share class will soon introduce a T share, the development would appear to be good news for fund investors. Pay 2.5% upfront for a T share, or double that amount for an A share, with both share classes having identical future performances? That seems like an easy call.

So, too, does buying T shares and holding them, rather than paying the standard 1% annual fee for no-load shares purchased through an advisory account. Within four years, if the T shares are not sold, they will be the better-performing of the two options. The math only improves over time. Consider a fund that gains 6% with its institutional shares. Its T shares, carrying the 12b-1 fee, make 5.75%. A $50,000 initial investment that is held for 10 years becomes $85,267 via the T shares, as opposed to $81,445 in the advisory account.

(The two amounts would be equal over the 10-year period if the annual advisory fee were 0.52%. For 20 years, the fee would need to be 0.39%.)

However, as a few readers reminded me, that analysis embeds certain assumptions.

For one, the T shares versus A shares cost comparison holds for smaller accounts but not necessarily for larger investments. Both share classes give volume discounts, but A shares do so more aggressively. Typically (the details vary among fund companies), the math converges for investments of several hundred thousand dollars. At $1 million, A shares will generally be the better deal—because most at that point waive their loads entirely, whereas T shares flatline at 1%. (A brokerage firm may waive that final 1%, if it so chooses, but the T share’s official fee schedule will not do so.)

Shares for the Slothful
The T shares calculation also assumes no sellers’ remorse. I learned from one well-placed reader that the major brokerage firms conduct “millions” of round-trip trades each year, wherein investors sell an A share fund, then shortly thereafter repurchase that fund. If those trades occur within a fairly short time period, that trade is load-waived for A shares. It would not be so with T shares.

Nor does my cost analysis incorporate the effects of long-term trades, including rebalancing. Investors who hold A shares may freely switch between funds of different asset classes, as long as they remain within the same family. With T shares, each such trade generates a new load charge.

In addition, there is the argument that all financial advisors’ services are not created equal. This is certainly true. Some give their views on investments only, while others opine on all matters financial. Some delight their clients; others displease them. However, I think this caveat is not very strong. Yes, financial advice should not be evaluated on price alone, but price surely is part of the analysis. The cost of T shares is such that if they come accompanied by good service, and held by the appropriate type of shareholder, they can be a compelling deal.

is vice president of research for Morningstar.

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