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Class “A” shares or Class “F” - which one is better?

A blog posting from an investment councillor caught my eye. The author of the article went to great lengths to denounce the fee-based mutual fund Class F share and advised his readers to avoid them. The investment counselling firm where he works has a fine reputation –catering to high net worth clients and generally, most investment councillors would favour fee-based arrangements because private investment councillors charge pretty much the same types of fees in about the same way as we do. Because his article was so unusual, I decided to look into the issues he raised.

Question: Which one is better? Class A or Class F?

Answer: It depends

Very soon, Canadian securities regulators will decide whether or not we will continue to use the current two model commission and fee-based system or whether Canada will effectively, ban all commissions like the UK and Australia for the purchase of stocks, bonds, mutual funds and other securities. Commissions have been around for centuries but depending on how things go – many commissions in Canada may soon disappear entirely. If commissions are banned, the only business model remaining is the fee-based model.

In this article we will focus on mutual fund commissions and fees, and the different types of mutual fund shares used for each. Commissions can be either embedded into the price of the mutual fund or be un-embedded and separated out like a bill. For simplicity sake, I define commissions as embedded commissions built into the price of the mutual fund. A fee however is a separate fee charged over and above the cost of the mutual fund.

Some investors prefer to pay separate negotiable annual fees usually consisting of a percentage of the value of the account. A typical fee might be 1% per year. If you wish to pay fees, investors have to buy a certain type of mutual fund share called Class “F”. Other investors prefer to pay a commission rather than a fee and have the commission built into the price of the mutual fund. This is the Class “A” fund.

In both cases, the fee or commission is fully disclosed to the investor.

Naturally, the Class “A” price will be higher than the Class “F” because the commission is already built into the price of the mutual fund. As such, you will see that the commission is built in the MER (Management Expense Ratio) of the fund. The Class “F” MER will superficially look a lot cheaper than the Class “A” fund because the separate advice fee is not included in the MER. This is because you are paying the fee separately out of your pocket or from your investment account. In reality, if the commission is the same as the fee –both Class A and Class F are equivalent (on a before-tax basis). To use an example, a mutual fund Class “A” with a MER of 2.46% is equivalent to a 1.355% Class “F” MER.

Here is how it works:

A 2.46% MER Class “A” share with a built-in 1% commission is equivalent to a 1.355% “F” Class share mutual fund that has a separate 1% fee. The difference of .105% is the extra blended GST/HST tax1 that an investor would pay on the separate 1% fee.

Some caution has to be exercised in directly comparing “A” share MERs with “F” share MERs. For comparison purposes, lower MERs are not necessarily better.

In some cases, depending on pricing, “A” shares can be a bargain. Conversely, there are instances where the “F” share is a bargain. Provincial/federal taxes or “mispricing” due to other factors may present opportunities for an advisor to explore both options with their clients. Generally though, the higher MER “A” shares should be more economic for smaller investors than “F”. And “F” shares should be more economic for large investors as fees are typically negotiable and proportionate to account size.

Back to the blog posting by the investment councillor...

In a nutshell, the author was railing against fee-based Class F shares because the negotiable fee of the Class F share in his example was greater than the fixed embedded commission of the Class A fund. Naturally, this would make the Class “F” share more expensive than the Class “A” share.

I think inadvertently, the author made the case for fixed embedded commissions rather than the alternative – separate fees. Embedded commissions are fixed by the fund company and are always disclosed to the investor prior to the purchase. However, fees on fee-based accounts are negotiable and each investor (depending on their negotiating skills) could get a fee that could be less than the fixed embedded commission or perhaps more.

So in the investment councillor’s example, why was the separate fee higher than the embedded commission? One factor is that unlike fixed embedded commissions, fees are open-ended and widely variable. For most large investment firms, fees start at 1.50% which is likely much greater than the lower fixed embedded commission. Or perhaps the issue could be that the advisor’s firm has a fee tier that is higher for smaller fee-based accounts? Or perhaps in this one instance, the investor failed to negotiate a good fee? Or maybe the advisor is a genius and charges everyone a premium fee to engage his services? That said, a low fixed commission is generally more preferable than a higher negotiable fee. A financial advisor should be able to offer you both choices and recommend the best one.

In either case, I have to disagree with the investment councillor’s conclusions. We definitely can’t say that Class F mutual fund shares are better or worse than Class A mutual fund shares. Fees are widely variable and can be an advantage or a disadvantage. Taxes can be a factor too2. It depends. Both have their proper place and have to be suitable and appropriate for each individual investor based on their personal circumstances.

1 Provincial taxes vary significantly between provinces and territories so GST/HST can vary between 5% and 15% depending on the province or territory you live in. In the example used above; a blended GST/HST tax rate of 10.5% is used.

2 Please refer to my article “After-tax considerations for fee-based accounts

Glenn Szlagowski is a Financial Advisor at Assante Financial Management Ltd. in Kitchener, Ontario. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd. This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please make sure to see a professional advisor for individual financial advice based on your personal circumstances. Commissions, trailing commissions, management fees and expenses, may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the Fund Facts and consult your Assante Advisor before investing.

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