Share classes

13 min read

Font

Discuss

Share

Feedback

Mutual funds with sales charges (loads) are typically categorized by class. How and when sales
charges are imposed defines their differences. In particular, we’ll cover these three share
classes:
 Class A shares (front-end)
 Class B shares (back-end)
 Class C shares (level load)
Class A shares (front-end)
Class A shares assess a front-end load, a sales charge collected when customers purchase
shares. This share class is subject to breakpoint schedules that determine the load based on the
amount of money invested. Here’s an example of a breakpoint schedule:
ABC Fund Class A Breakpoint Charge
Volume Sales Charge

$0 - $24,999 8.5%

$25,000 - $49,999 7.0%

$50,000 - $99,999 5.5%

$100,000+ 4.0%
As you can see, breakpoint schedules allow for lower sales charges when an investor purchases
more. Funds must offer breakpoint schedules if they assess the maximum sales charge of 8.5%.
A customer without the required funds for a lower breakpoint can sign a letter of intent (LOI), a
pledge to make an additional deposit for the shortfall in the next 13 months. By doing so, they
can obtain the lower sales charge right away.
Using the breakpoint schedule above, assume a customer had $20,000 to invest. They could
sign a $5,000 LOI pledging to make the shortfall deposit sometime in the next 13 months to
obtain the lower sales charge of 7.0% today (vs. 8.5%).
LOIs can also be backdated up to three months to include any previous purchases. Using the
previous example, the investor could reduce their LOI to $4,000 if they had made a $1,000
purchase a few weeks before the $20,000 investment. However, backdating the LOI does not
increase the time it covers. If an LOI is backdated three months, the customer only has ten
months to make the required shortfall deposit. If the customer fails to make the necessary
deposit, they will be retroactively assessed the higher sales charge.
Sidenote
The LOI & holding shares in escrow
Financial firms that facilitate the purchase of class A shares bought with an LOI typically require
a small portion of the investor’s shares to be held in escrow*. For example, a firm requires 5% of
the purchased shares to be held in a side (escrow) account. This provides the firm with some
collateral if the investor fails to fulfill the LOI. If an LOI is not fulfilled by the end of the
designated period (13 months), the firm can simply liquidate enough shares held in the escrow
account to pay for the higher sales charge.
*An escrow account is a legal holding account for capital (money) that may be spent later.
LOIs cannot be met by asset appreciation. If the position grows significantly in value, it does not
exempt the customer from making their shortfall deposit. However, funds provide rights of
accumulation, which results in lower sales charges for future purchases. For example, if a
customer had $40,000 invested in a fund and wished to make a new $10,000 purchase, they
would qualify for the $50,000 breakpoint on the new purchase.
Financial professionals must inform customers when they are approaching a breakpoint.
Assume a customer requests to purchase $24,000 of ABC mutual fund with the breakpoint
schedule referenced earlier. The registered representative is responsible for informing them
how to obtain a lower breakpoint (they are within $1,000 of the next breakpoint). The customer
has a few options: deposit the $1,000 shortfall now or sign an LOI. Either option will give them
the lower 7.0% breakpoint. Alternatively, the customer doesn’t have to do anything and can
simply accept the higher sales charge.
There’s an incentive for financial professionals to avoid helping their customers attain lower
sales charges. If a customer purchases $24,000 of the fund previously referenced, the firm will
make more money on the sale. Let’s look at the numbers:
 Sales charge if customer purchases $24,000 and pays a 8.5% sales charge = $2,040
 Sales charge if customer purchases $25,000 and pays a 7.0% sales charge = $1,750
As you can see, an additional $290 is charged if they don’t inform their customer of the next
breakpoint. If the customer is not notified, the financial professional engages in a violation
called a breakpoint sale. Breakpoint sales are subject to regulator-imposed fines and/or
suspensions. If a customer is close to the next breakpoint, it’s the representative’s responsibility
to provide them with options for attaining it. The representative must act as a fiduciary by
placing their customer’s interests before their own. This requires providing the best potential
options rather than prioritizing their paycheck.
Breakpoints are available to all individuals and some groups of people. Many funds
provide householding, which allows families living under one roof to add their purchases
together for lower breakpoints. Also, breakpoints apply no matter where or how many different
brokers the fund is purchased through. If you spent $10,000 at five different financial firms on
the same fund, it would be viewed as purchasing $50,000 of the fund (for breakpoint purposes).
Sidenote
Investment clubs
Investment clubs are groups of friends or colleagues that pool their money together for
investment purposes. Think of them as joint investment accounts for people with similar
interests and backgrounds. Investment clubs are not granted breakpoints and are assessed the
highest possible sales charge.
Investors can also utilize the combination privilege, allowing multiple purchases made within
one fund family to be added together for lower breakpoints. For example, an investor buying
$10,000 of the ABC Stock Fund, $10,000 of the ABC Corporate Bond Fund, and $5,000 of the
ABC US Government Bond Fund would qualify for a $25,000 breakpoint.
Class A shares are most suitable for long-term investors with large amounts to invest. The more
money invested, the lower the breakpoint. Front-end loads can be substantial, so it is only
suitable to liquidate (sell) shares after a long holding period. Otherwise, the investor would lose
significant money on the sales charge alone. The longer invested, the better the chance they
have to obtain returns that exceed their sales charge.
Class B shares (back-end)
Class B shares involve back-end loads, which are sales charges assessed when an investor sells
their shares. This load type is also called a contingent deferred sales charge (CDSC). The longer
an investor holds their shares, the lower the sales charge assessed. Here’s what a typical CDSC
schedule looks like:
ABC Fund Class B CDSC Schedule
Years of ownership Charge

1 year 8%

2 years 6%

3 years 4%

4 years 2%

5+ years 0%
As you can see, CDSCs award shareholders if their shares are held long-term. If a back-end load
applies during a redemption, the fund will remove the charge from sales proceeds before
making payment. Most CDSC schedules have a point where no sales charge is due. In our
example, shares held for 5 years or longer can be liquidated with no CDSC. Most fund
companies convert these shares to Class A once the CDSC period ends.
Class B shares are suitable for intermediate to long-term investors with smaller amounts to
invest. Longer-term investors with larger amounts to invest should consider Class A shares
because of their breakpoint schedules.
Sidenote
Class A vs. B for long-term investors
Sometimes, it’s difficult to determine whether Class A or B shares are suitable for a long-term
investor. As we’ve discussed above, here are the generalities:
 Class A - suitable for long-term investors with large amounts to invest
 Class B - suitable for long-term investors with small amounts to invest
Furthering the confusion, Class B shares often seem like the better choice. If an investor holds
their shares longer than the CDSC period, they pay no front or back-end load. So, why would an
investor choose Class A shares? To better understand this concept, let’s look at an example.
There are multiple share classes of the MFS Utilities Fund, including Class A and B shares. Let’s
establish the general fee structure for both:
MFS Utilities Fund Class A Shares
 Breakpoint schedule:
o 5.75%: $0 - $49,999
o 4.75%: $50,000 - $99,999
o 3.75%: $100,000 - $249,999
o 2.75%: $250,000 - $499,999
o 2.00%: $500,000 - $999,999
o 0.00%: $1,000,000+
 0.25% 12b-1 fees (annual)
MFS Utilities Fund Class B Shares
 Contingent deferred sales charge schedule:
o 4.00%: 1 year
o 4.00%: 2 years
o 3.00%: 3 years
o 3.00%: 4 years
o 2.00%: 5 years
o 1.00%: 6 years
o 0.00%: 7 years
 1.00% 12b-1 fees (annual)
Let’s assume an investor plans to hold shares for ten years and has $500,000 to invest. Can you
determine which share class is better?
The answer - Class A shares. With this share class, the investor will pay a 2.00% front-end load
and an annual 0.25% 12b-1 fee. Without complicating things with compounding fees, let’s
assume they’d pay 4.50% in fees (2.00% front-end load + 0.25% 12b-1 fees x 10 years).
If they had chosen the Class B shares instead, they’d pay 10.00% in fees, even with no back-end
load (1.00% 12b-1 fees x 10 years). Additionally, if the Class B shares converted to Class A shares
after the CDSC period (7 years), they still would pay 7.75% in fees (1.00% 12b-1 fees x 7 years +
0.25% 12b-1 fees x 3 years).
Besides the sales charge structure, the big difference between the two share classes is the 12b-
1 fees. This is why a long-term investor with a large amount to invest will be better off paying a
front-end load than choosing Class B shares (even without a CDSC).
Class C shares (level load)
Class C shares are primarily known for assessing ongoing marketing fees, subjecting investors
to level loads. This share class typically does not impose a front or back-end sales charge,
although some impose a one-year CDSC. In this structure, investors avoid a back-end sales
charge if the shares are held for at least a year.
The most significant expense for class C shares is 12b-1 fees. This is a marketing fee that aims to
lower a fund’s overall expenses by bringing more investors into the fund. Most mutual funds
maintain a relatively static expense ratio regardless of the amount of assets under management.
For example, let’s assume a fund with $100 million of current assets assesses $1 million in
annual operational expenses. At this asset level, the expense ratio is 1%. If the fund could
double the size of its assets under management (to $200 million) while maintaining the same
expense ratio ($1 million), the expense ratio would fall to 0.50%.
12b-1 fees are used to grow a fund’s assets in hopes of lowering a fund’s expenses on a per-
investor basis. There are two components of this type of fee. Distribution fees pay for
marketing and promotional services, including advertisements and payments to brokers that
place customers into these funds. The maximum distribution fee that may be assessed is
0.75%. Service fees pay representatives to answer questions and discuss attributes of these
funds as all advertisements include contact information (e.g., “Call us if you have questions!”).
The maximum service fee that may be assessed is 0.25%. Combining the distribution and service
fees results in a 1% maximum annual 12b-1 fee.
Each share class assesses a unique 12b-1 fee. These are the typical fee structures:
 Class A shares = low or no 12b-1 fees
 Class B shares = moderate 12b-1 fees
 Class C shares = maximum 12b-1 fees
Regulators keenly know that ongoing 12b-1 fees eat away at investors’ returns. Therefore,
relevant regulations do not allow a fund charging a 12b-1 fee of more than 0.25% to market
itself as a “no load” fund. Otherwise, an investor may purchase a fund thinking it is efficient
(low fees), while being assessed an annual marketing fee that never goes away. Although many
Class C shares don’t maintain a front or back-end sales charge, the fund company could not
market shares as “no-load” because of their high 12b-1 fee structure.
Sidenote
12b-1 fee impact on loads
Funds assessing the maximum 12b-1 fee (1%) cannot also impose the maximum 8.5% on front
or back-end loads. Instead, the maximum possible load is reduced to 7.25%. The regulators
impose this rule to ensure investors are not subject to extraordinary fee schedules.
Class C shares are suitable for short-term investors. With the ongoing costs that 12b-1 fees
present, long-term investors want to avoid this share class. Although a maximum 1% fee may
seem low, these fees are continuously imposed. If an investor held Class C shares for ten years,
they will pay the 1% annual fee ten times!*
*Technically, 12b-1 fees are assessed quarterly, although the fee is expressed as an annual
percentage. For example, assume an investor owes an annual 12b-1 fee of $100. The fund would
charge $25 per quarter instead of a one-time $100 fee.
Key points
Class A shares
 Front-end loaded funds
 Sales charge assessed at purchase
 Subject to breakpoint schedules
 Low or no 12b-1 fees
 Suitable for:
o Longer-term investors
o Larger investments of money
Letter of intent (LOI)
 Pledge to deposit breakpoint shortfall
 Lower sales charge assessed
  Lasts 13 months
 Can be backdated up to 90 days
 Retroactive charge if not fulfilled
Breakpoint sales
 Failure to notify investors of breakpoint
 Violation subject to penalties
Combination privilege
 Allows merger of multiple purchases for lower sales charge
Class B shares
 Back-end loaded funds (CDSCs)
 Sales charges assessed at redemption
 Moderate 12b-1 fees
 Suitable for:
o Longer-term investors
o Smaller investments of money
Class C shares
 No sales charge or a 1-year CDSC
 High 12b-1 fees
 Suitable for:
o Short-term investors
12b-1 fees
 Marketing and promotion fees used to reduce expense ratio
 Maximum fee of 1%
o Distribution fee max = 0.75%
o Service fee max = 0.25%
 Funds limited to 7.25% loads if charging maximum 12b-1 fee
 Cannot market fund as “no load” if charging higher than 0.25%