'High commission' fund sales appear to be on the wane

MARKETWATCH

Your Money

June 03, 2008|By CHARLES JAFFE

A growing number of mutual fund sales are made by financial advisers, but a shrinking number of those transactions are carrying traditional point-of-sale commissions.

While that trend has been going on for several years, what it showcases today is the very real possibility that many consumers don't have a clear understanding of what they are paying for financial advice and how those charges have an impact on their returns.

A new study issued last week by Strategic Insight, a New York-based fund industry research firm, showed that about 60 percent of all sales through advisers last year occurred without front-end loads. In many cases, commissions were waived, either because the fund was sold in a retirement plan, a wrap account or through a registered investment adviser - or the adviser charged a flat advisory fee to put clients into no-load funds.

The traditional "high commission" sale - with a sales charge of 4 percent and up - has become a thing of the past, representing just 6 percent of all intermediary-distributed fund sales last year, according to Strategic Insight.

"High commissions have become obsolete," says Avi Nachmany, director of research at Strategic Insight. "But that doesn't mean consumers are better off. They have more options on how to pay advisers, but it's not all as clean and easy as it seems."

Commission sales have an obvious problem for investments, namely that the guy pushing the product gets paid for making the sale, giving the seller a vested interest in closing the deal and then moving on to the next one. While rogue brokers and salesmen have been rare, the abusive cases attracted a lot of attention, which in turn pushed the industry toward other solutions.

As a result, mutual funds were created with back-end sales charges, so-called "level loads" - where they have no actual sales charge but carry higher continuing costs forever - and programs that allowed investors to buy in without the commission charge.

While there's an inherent conflict of interest in funds sold on straight, upfront commissions, it's also the most direct way to pay for financial help, a once-and-done charge where the conflict is obvious and out in the open. Moreover, countless studies have shown that A-shares - where commissions are paid upfront - tend to be cheaper than other share classes provided the buyer holds the fund for five years or longer.

Further, an adviser giving bad advice tends to be uncovered pretty quickly in a world of front-end commissions; if they convince a client to make one move and then go back and alter that decision shortly thereafter, it quickly becomes apparent that their flip-flopping is designed to generate commissions.

By comparison, a fee-only adviser with an unhappy customer might make moves to appease that client, trades that the adviser would not otherwise suggest, except that standing pat would cost them the business. There's the same conflict but, when moves are made under the guise of making the client happy, it's easy to miss the possibility that the changes are made more to keep the back-end loads, 12b-1 fees or adviser charges flowing.

These days, financial advisers go by all sorts of names, from broker to financial planner to things like "wealth counselor." What's clear is that for all of the different names, they're attempting to do the same thing, namely get paid for giving financial advice.

For consumers, the focus is no longer "load or no-load" or even "A, B or C shares," it's "cost of ownership." That includes the costs from inside the fund in the form of expense ratios and then any other costs associated with investing.

For example, an investor who hires a fee-only broker charging an annual fee of 1 percent of assets under management would be tempted to look at that cost separate from their investment dollars. Instead, if they looked at it in the same way they'd think of a 12b-1 fee - technically a trailing sales charge paid to an adviser - they'd be better able to tell whether they are getting what funds are supposed to deliver, specifically "professional management at a reasonable price."

If an adviser charges excessively for his services, it won't make much difference if they pick low-cost funds; the investor is still paying too high a price for ownership.

With potential changes in the works for the way certain fees - like the 12b-1 - are calculated and disclosed, it will only get increasingly difficult for advice customers to figure out if they are getting a good deal for their money when it comes to buying funds.

"The debate on the best way to pay, which clearly favored point-of-sale commissions as being the best deal, has been lost, but having more options is not bad," says Nachmany. "It's just more important than ever that fund customers understand what they are paying, who they are paying and how they are paying, because it's not straightforward anymore, and it's not going to be that way again."

cjaffe@marketwatch.com

Charles Jaffe is senior columnist for MarketWatch and the host of Your Money Radio. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.

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