Hallett suggests DSC revamp

(August 18, 2005) Fund companies should consider giving investors a break on their fees once their DSC schedule runs its course, according to one prominent fund industry analyst.

“Industry critics and investor advocates call the system unfair since fund companies easily recoup the cost of the upfront commission paid in well under six years,” says Dan Hallett of Dan Hallett & Associates. “They argue investors should get a break on fees after they’ve fulfilled their six years in a fund family.”

Such critics say investors are trapped in their DSC funds, as they are reluctant to pay the often punitive early redemption charge. Once the DSC schedule has elapsed, investors may sell off their holdings just to be free of them, regardless of whether they are sound long-term investments.

In response to such criticism, Hallett is advocating a new class of fund unit, dubbed “D-class”, which the investor would be rolled into once the DSC schedule is complete. The upfront sales commission of 4% or 5% costs the fund company about 50 to 80 basis points annually. Hallett suggests this amount could be cut from the D-class unit’s management expense ratio, rewarding investors for their patience.

“In a maturing fund industry with fewer sales into DSC funds, assets are more mobile than ever,” Hallett says. “Investors might actually stick around longer if the companies with which they entrusted their life savings actually gave them a monetary incentive to be a long-term investor.”

D-class units would not be available to investors as initial investment, with the rollover of DSC units being the only way to access them. But Hallett suggests investors could be allowed to switch between D-class fund units within the same fund family.

Such a class of fund units would be a “win-win-win” situation, according to Hallett, benefiting the investor, the advisor and the fund company. Investors not only get lower fees, but would also be encouraged to take a longer term approach to their fund holdings, as they are “rewarded” with a lower MER, for sticking with the fund company.

“Fund companies would take a margin haircut but have greater certainty of revenue since D-class shares are likely to be stickier,” Hallett says. “Plus, advisors don’t suffer a pay cut.”

He admits there is no real added incentive for advisors, as the change could eliminate the demand for switching to front end load units, which yield a higher trailer.

“The industry trend is for fund companies to give up some of their revenue while bumping up advisor compensation,” he says. “Perhaps what fund companies give up in annual revenue (under the hypothetical D-class plan) should be shared by advisor and client. That way, clients still have an incentive to keep owning funds in the family and advisors have incentive to keep them there with a trailer fee that is in the middle of front end load and DSC.

“I think advisors, on balance, add value to their clients’ net worth. And giving clients a break without affecting their compensation is a good thing.”

What do you think of Hallett’s idea? Share your thoughts in Advisor.ca’s online forum, the Talvest Town Hall.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com