BROKERS HAPPY TO BACK INTO PROFITS FROM ANTI-FRONT-END-LOAD INVESTORS UPFRONT CHARGES DYING OUT AS BUYERS RESIST PAYING BEFORE RESULTS

Stockbrokers have taken much heat for resisting the trend to sell mutual funds that don’t pay them an upfront commission, but a recent study by a consulting firm suggests they are giving in.

Mutual fund companies that specialize in selling their wares through brokers, have seen portfolios with A shares, or upfront sales charges, make up only 38% of all sales, compared to 90% in 1990, according to Boston’s Financial Research Corp. At the same time, A share assets have dropped from 85% of overall holdings to 67%.

“Front-end load shares are sort of a dying breed,” says Ray Liberatore, the analyst who wrote the report.

Taking over are B shares, which provide a back-end load, meaning investors pay no sales charges unless they sell fund shares within a given period. B shares were devised to give brokers ammunition against no-load funds, and the growing ranks of independent advisers who charge a fee rather than a commission. Mutual fund companies like B shares, which discourage investors from pulling money out of their portfolios.

Investors who buy A shares see a percentage of their initial investment — usually 4.75% or more — lopped off the top as commissions to the broker or planner selling the fund.

Meanwhile, mutual fund companies pay a commission as high as 4% or more for new B share sales. They figure the new business is worth the cost. With B shares, the investor also pays increased annual management fees, some of which go to the broker as “trailing” fee income, and some of which go to the fund company to repay itself for fronting the broker.

not a great bargain

Thus, Mr. Liberatore and many others doubt that investors are getting the great bargain they think they are with B shares. First, they may not understand that a B share investment carries recurring annual management fees that are 0.75% higher than those of A shares, on average.

“Most investors don’t know the expenses are higher,” Mr. Liberatore says. Even though they may be informed by their broker or planner, he adds, “That information probably isn’t getting processed.”

“They’re just calling the load a fee. It’s the same thing,” agrees D. Randolph Waesche, a partner in Resource Management Inc., a fee-only adviser based in New Orleans.

Observers add that most investors will probably end up paying some commissions on B shares, since they’re likely to cash out of the fund before the minimum holding time elapses. Depending on the wholesaler, most funds require that five to seven years pass before investors can redeem shares load free.

Clearly, the back-end load has become the sale of choice, even though it may pay less in commissions than an A share deal.

“If I’m bringing in new money, I’ll go B shares,” says Steve Briggs, a certified financial planner at Merrill Lynch in Bloomfield Hills, Mich. “You get your 4% right up front, and you walk out to your car with a smile.”

Mr. Briggs disagrees that B shares are more expensive. Load levels for redemptions decline each year the fund is held, until they finally disappear altogether. As long as investors hold the fund until after the waiting period ends, the fund’s annual fees revert to A share levels, he says.

“They’re pretty much cost-neutral after six or seven years,” Mr. Briggs says.

Whether the average investor holds a fund that long is an open question. Mr. Liberatore says his company has never done a study on the issue, and he’s never seen such data anywhere else. But, he says, “Three to four years is probably the average stay in an equity fund.”

Mr. Waesche agrees. “Even with registered investment advisers who recommend mutual funds, turnover is much more than the public expects,” he says. “It’s every three years.”

As for the higher management fees, Mr. Briggs says he makes it a practice to disclose the costs of B shares when clients are deciding which way to go. “I would assume that financial consultants always make that full disclosure,” he says.

Whatever the case, don’t be surprised if upfront loads eventually vanish from the landscape. As Mr. Liberatore says, “I don’t think people mind paying something, as long as it’s not up front.”