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Clean Shares: Yet Another Mutual Fund or Future ETF Competitor?

Clean shares are popping up in the U.S. Several firms, including Capital Group, Janus Henderson Investors, MFS, and T. Rowe Price, offer them. The shares came about from a Securities and Exchange Committee no-action letter issued on January 11, 2017, responding to Capital Group’s request for interpretative guidance on Section 22(d) of the Investment Company Act of 1940.

A clean share is a mutual fund share with no distribution fees, such as a 12b-1 fee or a sales load built into the structure of the fund, although there is no official definition. Firms may include or exclude administrative costs (e.g., sub-transfer agency [sub-TA] fees for record keeping, fulfillment, or other expenses such as cybersecurity measures), which is potentially confusing to investors. Advisory firms then overlay an advisory fee for advice and implementation in a managed account scenario. In the retail sector, brokers add a commission amount for processing.

A clean share scenario allows an easier comparison of fees across firms, not only in terms of price but also in terms of the specific advisor services. The consolidating, competitive wealth industry has been heading in this direction. Financial advisors are having to demonstrate specific value in the client relationship.

The existing alphabet soup of U.S. mutual fund classes (US$18.9 trillion in assets) runs the gamut of fees and fee types set by the manufacturer. The industry sentiment is something for everyone in every scenario. However, during financial institution preparations for the Department of Labor’s fiduciary rule, many firms shifted to lower-cost institutional shares or standardized T-shares, or simply rebated the sales load on A-shares (which seemed easier than introducing and discussing an entirely new share class to clients). But clean shares may well find their place. Market drivers are shifting us all toward greater transparency but also create challenges to cost unbundling:

  • Society: The millennial client market is the subject of a future transfer of wealth and feels unencumbered with historical financial advisor ties. Studies show these consumers are doing their homework regarding product choices. These days, investors generally are keen to make apples-to-apples comparisons and are better able to do so, with apps and the internet as resources.
  • Industry: Well-known is the growing prominence of fee-based advisory, which is gaining momentum under the fiduciary concept. Clean shares play nicely in a fee-based environment. A pure clean share could affect the use of exchange-traded funds (ETFs) on platforms. The ever-growing ETF market (with a January 2018 record of US$5 trillion in assets) charges a low expense fee (typically about 0.6%). In a brokerage account, a transactional commission from an online discount broker is typically US$7. Clean shares may flow easily to robo-advisory platforms, providing more product variety to a U.S. market dominated by ETFs (and by the top five providers).
  • Regulators: Regulators’ 2018 announcements make it clear they are examining financial product fees and calling for greater transparency and advisor accountability. This is more easily done when each participant of the wealth value chain sets a price for that value, which the client and regulators can evaluate.
  • Distributors: Distribution firms may well appreciate pricing control. Yet decisions are numerous. The broker-dealer’s processing overhead plus the financial advisory fees are a line item, as are any custodian/sub-TA fees for their contribution to product delivery. This means a new line item requiring explanation. Broker-dealers that collect and transfer any sub-TA fees will want a processing fee to do that work. What are appropriate fees? What new contracts will be needed? All questions outstanding for brokers if clean shares become the norm.
  • Manufacturers: Some manufacturers may find easier entry to distribution channels with the simple class share. There might be less effort on shareholder servicing and expenses. Fewer share classes (filings, maintenance) would represent lower costs. That said, all the other share classes are unlikely to disappear completely any time soon.
  • Financial advisors: Advisors may feel encumbered with explaining line items to clients, and the itemization of expenses added to a clean share might be daunting to the investor.

Clean shares are not a question mark. Rather, the industry is evolving to solve challenges. In this case, the movement is toward simplicity, transparency, and customer value.