12b-1 fees as we know them may soon be dead, if the Securities and Exchange Commission
has its way, and their quasi-death could have big implications for mutual fund firms working inside 401(k)s. American Funds
and other fund firms in the micro market may face more of an uphill battle than ever before, while fundsters who reach out to insurance-based 401(k) providers may see greater success. Fundsters looking for retirement plan distribution should take heed.
Last month, the SEC proposed killing off the 12b-1 label altogether, while limiting ongoing, 12b-1-esque "market and service" fees to 25 basis points per year (see The MFWire, 7/21/2010
). Any ongoing sales charges above that 25 bps, meanwhile, regardless of share class, would not be allowed to add up, over the years, to more than the maximum sales load for any share class (usually an A share) of the same fund.
As is, this proposal shouldn't affect institutional share classes used by many 401(k) plans -- because institutional shares normally lack 12b-1 fees -- and load-based A shares often have low enough 12b-1s (25 bps or less) that this shouldn't be a big change for plans using them, either. Sub-TA fees, often used to compensate recordkeepers or administrators, may escape unscathed, too.
But what about R shares? A few asset managers -- including American Funds
-- have rolled out multiple share classes designed for use inside of advisor-sold retirement plans. Those R share classes are specifically differentiated based on different levels of 12b-1 fees used to compensate the plan's advisor, recordkeeper or TPA.
Spokespeople for American Funds, JPMorgan and Thornburg all declined to comment for this story.
To examine the potential impact of this proposal, consider the classic R shares shop, American Funds, which has six classes of R shares as well as a class of A shares. R-4 shares charge only 25 bps in 12b-1 fees, and R-5 and R-6 charge no 12b-1 fees at all, meaning that all three classes should be unaffected. R-3 shares and below, however, charge between 50 and 100 bps of 12b-1 fees, leaving them with 25 to 75 bps above the SEC's proposed ongoing maximum. A shares for the American Funds 2055 Target Date Retirement Fund
come with a 575 bps load, which would become the new maximum total ongoing sales charge above the 25 bps annual fee for the other shares.
So an R-1 share, with 100 bps of 12b-1, would have 75 bps of that counting as ongoing, asset-based sales charge, meaning that it would take less than eight years for that fund to hit that 575 bps maximum dictated by the A shares' load. R2 shares' 75 bps of 12b-1s (50 bps in "excess") would take less than 12 years to hit the max, R3 shares' 50 bps of 12b-1s (25 bps in "excess") would max out in 23 years. All of those time frames are shorter than the career length, say 35 or 40 years, of a participant who could be deferring that entire time.
American Funds certainly isn't the only fund company with R shares that might be affected. JPMorgan's R2 shares charge 50 bps in 12b-1s -- its R5s charge none. Invesco's R and R5 shares charge 50 bps in 12b-1s. Principal
's R-1 and R-2 shares charge 35 and 30 bps, respectively, in 12b-1s -- -3s charge 25 bps, R-4s 10 and R-5s none. And Thornburg's R3 shares charge 50 bps in 12b-1s -- R5s charge none. And one retirement plan advisor noted that most plain, numberless R shares, which are offered by many fund firms, charge 50 bps in 12b-1s.
American Funds and OppenheimerFunds
offer not just mutual funds but fully bundled 401(k) products in the micro-market, products that are exclusively distributed by advisors who are compensated via 12b-1 fees. The one-two punch of 12b-1 reform and new 401(k) fee disclosure regulations from the Department of Labor
could hit such platforms hard.
Meanwhile, much of their competition comes from variable-annuity-based 401(k) platforms from insurance companies. Those products will still have to comply with the DoL's new 401(k) fee disclosure regulations, but they will avoid 12b-1 reform by virtue of not directly using mutual funds. So asset managers looking for 401(k) distribution may either pull their target market up a bit, towards small or mid-market plans or larger, or focus their distribution efforts on variable annuities via insurance providers instead of defined contribution investment-only slots on micro-market platforms.
Micro-market offerings used by fee-based RIAs, who don't need 12b-1s, may also see a boost over traditional broker-sold offerings, and unlike the insurance providers they may not fear the new 401(k) fee disclosure regulations either. So fund firms may also consider focusing their DC I-O efforts in the micro-market on RIAs and not on the platforms, given that the RIAs are likely to use open architecture recordkeepers anyway.
Of course, the idea is simply a proposal, and the SEC has opened up a 90-day window for public comments. 12b-1 fees still survive, at least for now.
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