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Chapter 10
Retail Sales
Distribution Channels for Mutual Funds
Retail Sales
Intermediary
channel
Direct channel
Sales made
through third-party
salespeople.
Sales made
directly by a fund
or through a fund
supermarket.
Retirement
channel
Sales made
through employersponsored
retirement plans.
What Sells Mutual Funds?
• Outstanding investment returns.
– Though this is rarely a successful investment strategy.
– High Morningstar ratings are particularly valued.
• Some investors look for funds with high yields or low
expenses.
• Advertising.
• The recommendation of a financial adviser.
The Intermediary Channel
Advice is the key selling proposition of the intermediary
channel.
– Firms in this channel work through representatives who provide
investment advice.
Intermediary Channel Segments (1)
Broker-dealers
Banks
• Wirehouses: national firms.
• Independents: typically a few
professionals.
• Regionals: often provide support
networks for smaller firms.
• Generally don’t manage funds, though in
the past had large proprietary fund
groups.
• Representatives often called financial
advisers.
• Large managers of funds
• Own the wirehouses.
Intermediary Channel Segments (2)
Insurance companies
• Largely sell funds as part of variable
annuities.
Registered investment
advisers (RIAs)
• Fees are based on level of client assets.
• Don’t sell proprietary funds.
FAs vs. RIAs
Financial Advisers
Registered
Investment Advisers
Regulated under the Securities
Exchange Act of 1934.
Regulated under the Investment
Advisers Act of 1940.
Paid through commissions; can’t
received asset-based fees.
Paid through fees based on
assets; can’t receive
commissions.
Not required to send brochure.
Required to send clients a
brochure.
Currently subject to suitability
standard of care (though this is
under review).
Subject to fiduciary standard of
care.
Selling through Broker-Dealers
When selling through broker-dealers, mutual fund
management companies try to increase the visibility
of their funds by:
• Having a large sales force, known as a wholesaling team.
• Participating in wrap programs when possible.
– Broker-dealers select funds to participate in the wrap program.
– Financial advisers choose funds from the program for their clients.
– Clients pay an annual fee to participate, but don’t pay a sales load.
Compensation for Selling Fund Shares (1)
Direct
client
charges
Fees imposed by
fund
Fees paid by the
management
company
Paid by client
directly to
intermediary.
Paid by client indirectly
through the fund to the
intermediary. The payment
from the fund to intermediary
is the reallowance.
Paid from the management
company’s profits and not by
the client.
Front- and
back-end
loads
12b-1 fees
Revenue
sharing
Sub-transfer
agent fees
Compensation for Selling Fund Shares (2)
Direct client charges
Front-end load
• Fees paid by client directly to the
intermediary.
• Include wrap program fee and fees
charges by registered investment
advisers.
• Paid when buying fund shares.
• Paid directly from the shareholder’s
account to the fund.
• Often reduced through breakpoints for
larger investment amounts.
• Often waived for certain types of
investors.
• Added to the NAV for the offering price.
Compensation for Selling Fund Shares (3)
Back-end loads
12b-1 fees
• Imposed when shareholder redeems.
• Generally imposed only when the
investor has owned shares for less than
a specified period of time.
• Often decrease with holding period and
called contingent deferred sales charges
(CDSCs).
• Annual fee paid by the fund.
• Included in expense ratio.
Compensation for Selling Fund Shares (4)
Revenue sharing
Sub-transfer agent fees
• Also called marketing support.
• The management company is effectively
sharing part of its fee with the
intermediary.
• Payments for maintaining shareholder
records in omnibus accounts.
• Paid by the transfer agent which is
usually owned by the management
company.
Share Classes
Funds may offer investors different combinations of
loads and 12b-1 fees, each in a different share class.
Typical classes are:
• Class A: traditional load shares with high front-end load and low
12b-1 fee.
• Class B: high 12b-1 fee and CDSC. No front-end load. No
longer offered by many funds.
• Class C: level load shares that combine a high 12b-1 fee with a
modest CDSC.
• Class I: institutional shares with no load or 12b-1 fee.
• Class R: retirement plan shares with a moderate 12b-1 fee.
Direct Channel Segments
Direct marketers
• Sell directly to investors.
• Generally do not impose a front-end load
on sales of fund shares; therefore, often
called no-load fund segment.
Fund supermarkets
• Brokerage firms that enable investors to
buy funds from many fund families in
one account.
• Investors typically do not pay a load
when buying shares through a
supermarket.
• Funds and fund management companies
companies pay fees to participate in the
supermarket.
No-Load Funds
A fund may call itself no-load as long as it doesn’t:
– Charge a front- or back-end load.
– Charge a 12b-1 fee greater than 25 basis points (0.25%).
No-load funds often have two classes of shares:
– Class I: pure no-load, with no sales loads or 12b-1 fees at all.
– Class N: no front-end or back-end loads, but with a 12b-1 fee
(which can’t exceed 0.25%).
The Impact of Fund Supermarkets
Fund supermarkets have had a tremendous impact on
the structure of the mutual fund industry. They have:
– Boosted the growth of the registered investment adviser
segment.
– Created opportunities for boutique firms, by providing them
with cost-effective distribution.
– Helped blur the lines between load and no-load funds.
• Load funds are often sold through fund supermarkets, but with their
loads waived.
Open Architecture
Open architecture gives clients access to funds from
many different fund sponsors, not just a proprietary
fund managed by the distributor.
Open architecture has:
• Increased competition in the fund industry.
• Led to the same funds being offered in many channels and
blurred the line between load and no-load funds.
• Created market challenges for fund sponsors. They must:
– Place their funds on open architecture platforms.
– Find a way to differentiate their funds from the competition.
Categories of Mutual Fund
Advertisements
•
Performance
•
Investment category
•
Retirement themes
•
Costs
•
Brand
•
Investment advice
•
Online trading and account access
Needs-Based Products
Needs-based products address a particular investor
requirement. Examples:
• Section 529 plans
– College savings accounts with tax advantages.
• Donor-advised funds
– Often called charitable gift trusts.
– Allow individuals to establish a tax-advantaged account to be used
for future charitable donations.