THEY SELL C SHARES FOR REVENUE STREAM: LOAD FUND INVESTORS DON’T MIND PAYING MORE OVER LONG TERM

Though it’s not a free lunch, more mutual fund shareholders are opting to pay their broker a percentage of assets under management each year.

Known as C shares or level loads, these mutual funds have snagged more than 40% of load market sales this year, compared to 20% in all of last year, reports Financial Research Corp. of Boston.

Though new sales of load funds in general declined 68% in the first eight months of the year compared to the same period in 1988 – to $28 billion from $89 billion – C shares dropped just 7%. A and B shares, those that charge an upfront or back end fee respectively, have been the most battered, says FRC analyst Chris J. Brown.

“People who are redeeming A shares are just redeeming them at a faster rate,” he points out. “And they’ve been around for a lot longer.”

Though they don’t pay an upfront load, holders of C shares are charged a redemption fee if they take their money out within the first 12 to 18 months.

Brokers like C shares because they charge 1% of assets annually, as allowed by the Securities and Exchange Commission’s rule 12(b)1, and lock in an annual revenue stream.

happy trails

A shares, by comparison, typically charge 4% or more up front plus 0.25% in 12(b)1 fees. The 12(b)1 fees on B shares are higher until the broker’s commission has been recouped, then they are reduced to 0.25% generally.

The downside for investors is that those who hold the shares for the long term will end up paying much more over time than those who invested in the other classes of shares. For brokers, the break-even point for a level-load fund is four years. And investors who stay with a mutual fund for less than eight years are likely to reap benefits without paying through the nose.

While the investment seems to be winning over some brokers, it has met with some resistance too.

“It was tough to get brokers to sell these, especially young brokers if they don’t have a big book of business,” Mr. Brown explains. “They need the upfront fees.”

But brokers who have been in the business for some time seem to be more amenable to the idea and have found C shares an added boon because they provide a steady revenue stream, says Mr. Brown, a former broker with Salomon Smith Barney Inc.

“In the long run, beyond five years, it pays a financial adviser more money, assuming a certain rate of return,” says Christopher Davis, a financial planner with First Union Securities in Charlotte, N.C.

Mr. Davis says he has seen increasing interest in level loads from clients who want to try new specialty funds like Internet portfolios and don’t want to be locked in for a long time.

Not surprisingly, Legg Mason Funds, which offer almost exclusively C shares that charge a 1% annual fee for stock portfolios and 0.5% for bond funds, has benefited most from the recent trend.

“It puts brokers and clients on the same side of the table,” says Talbot Daley, director of marketing for the unit of Baltimore-based Legg Mason Inc. Legg Mason Wood Walker Inc., the funds’ regional brokerage affiliate, has a sales force of almost 1,200.

like a level load field

Clients like level loads because brokers make more money when the fund goes up and they don’t make as much if the funds go down and assets slip, Mr. Daley says.

From the broker’s perspective, pushing C shares is a way to compete with no-load funds and the rise of low-cost online transactions. “Psychologically, clients are more able to accept the no-commission structure,” Mr. Daley says.

Even though this year has been a relatively good one for C shares, FRC’s Mr. Brown wonders how well they can compete with the wrap-fee products they so much resemble. Investors may opt for wrap-free programs that go beyond just mutual funds.

That’s the goal brokers should strive for anyway, Mr. Daley says. “Assets will stay from the performance of the fund and from the service given to the client by the broker.”