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Fund Times

Fund Times: Dreyfus Drops B Shares and Danoff Invests $1M in Contra

Plus, a fund that counts a brother-in-law as independent and the worst-performing fund in 2006.

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Two new developments may spark trends that will lead to greater clarity on fees paid by fund investors. Lehman Brothers is reportedly moving ahead with efforts to unbundle brokerage commissions from research, and Dreyfus has eliminated sales of B shares.

Dreyfus' move to eliminate sales of B shares makes it the second fund company to do so. Franklin-Templeton eliminated B share sales in 2005. The moves help to ensure that investors understand what they're paying in commissions. B shares are designed to take the traditional front-load commission and spread it out over time through the expense ratio. Depending on their design and the timeframe involved, some B share purchases can produce equivalent, or even better, results for shareholders.

However, few B share structures fit that description, and overall, their sale has opened up a Pandora's box for abuses by brokers. The simplest problem that B shares create is that many investors come away thinking that they didn't pay a commission and got no-load shares because they didn't pay an up-front fee. Sometimes this was simply a matter of confusion, and other times it was a result of deliberate deception.

Another common abuse has been that brokers eager to capture the highest commission possible have sometimes put clients in B shares when they would have been entitled to lower commissions had they bought A shares. Fund companies include commission breakpoints with A shares so that investors buying large sums pay a reduced commission or no commission at all.

For example, a fund might cut the load in half for an investor buying $500,000 or more. But some brokers have been caught putting clients in B shares (which don't have a way of reducing commissions) when they have more than that amount. In some cases, brokers would fill multiple orders just below the $500,000 level in order to avoid detection.

The NASD has brought a number of enforcement actions against brokers who took such actions. In addition, brokerage firms and fund companies alike have become more vigilant in policing sales of B shares. A number of fund companies have also lowered the maximum amount allowed in B shares in order to make abuses much more difficult.

The moves by Franklin and Dreyfus are good news for fund investors as it's easier to understand the commission in A shares and they're generally less susceptible to abusive sales practices.

Meanwhile, Lehman Brothers is following up its landmark deal with Fidelity to unbundle research and commissions by talking with other asset managers about a similar deal. Currently, most mutual funds pay for Wall Street research with soft dollars, which take the form of higher trading commissions. These come out of fund investors' pockets but are not included in the expense ratio. That's because the brokerage commissions that a fund incurs every time it buys or sells a security come out of fund assets yet are not among the expenses counted in the expense ratio.

Fidelity pushed Lehman to charge it separately for research, and now Lehman is in talks with other firms regarding a similar deal, according to The Wall Street Journal. Fidelity is also in talks with other Wall Street firms about cutting similar deals. Fidelity says the deal enables it to lower the brokerage commissions charged to its funds.

Danoff Invests More Than $1M in Fidelity Contrafund
A new filing from Fidelity reveals that  Fidelity Contrafund (FCNTX) manager Will Danoff has more than $1 million of his own money invested in the fund. That's good news for Contrafund investors as it shows Danoff eats his own cooking. Danoff also has more than $1 million in the $5 billion  Fidelity Advisor New Insights (FNIAX).

On the downside, the filing also revealed that Danoff runs about $81 billion in total. Contrafund is about $64 billion of that total.

A new filing for  Fidelity New Markets Income (FNMIX) shows that John Carlson doesn't own any shares.

Frontier Equity Lists Brother-in-Law as Independent Director
Less encouraging is the high-cost, small-asset Frontier MicroCap  (FEFPX), which now lists the brother-in-law of the fund president as an independent director. Amy Siesennop is the president, treasurer, compliance, and anti-money-laundering officer for the fund. However, her brother-in-law, Thomas Siesennop, is listed as an independent director.

Also discouraging is the fact that only three directors including manager Joel Blumenschein hold anything in the fund, and they only made it into the lowest category of between $1 and $10,000. The filing also stated that officers and directors of Frontier as a group own less than 2% of the shares of the fund.

T. Rowe Price GNMA to Invest in Nongovernment Mortgages
 T. Rowe Price GNMA (PRGMX) has amended its prospectus to allow it to invest a portion of assets in mortgage securities not backed by the U.S. government. Whereas the fund had been required to invest 100% of assets in federal-government-backed debt, it now only has to invest 80% of assets in GNMAs.

Senior analyst Scott Berry applauded the move because other funds with similar structures have been able to boost returns without taking on much more risk.

Who's the Worst?
The fund with the biggest year-to-date loss is Potomac Small Cap/Short (POSSX), which is down 17.4% through Feb. 27. The fund is a leveraged short bet against small caps. The biggest gainer is the equally extreme ING Russia  (LETRX), which is up 29.4% already.

Russel Kinnel does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.