Here’s why all this matters.
The end result is that we have all these different ways that mutual funds get sold and distributed to the public. And all the different distribution deals have led to this massive proliferation of mutual fund share classes. Because each different share class is basically a different sales distribution deal. That’s why we’ve got A shares with one kind of selling deal, C shares with another, F-1 with another, F-3 with another, and R-1 through R-6 all with another, all the way down the line.
But in the end, if we’re going to get shifted to a fiduciary duty, the reality is you really only need one share class: whichever one is the cheapest. Not the other 16. Just that one!
There is a common point of confusion about the fiduciary rule: the belief that it would require advisors to always recommend the single lowest-cost investment solution that exists. As though everyone is just going to be required to use a handful of Vanguard and BlackRock ETFs at a cost of about three basis points each.
But that’s actually untrue. There is not a requirement under the fiduciary rule to always find the one lowest-cost investment on the planet to the exclusion of all others. Nor is there any requirement to use low-cost passive funds in lieu of active ones. That’s a myth.
What the rule does require, though, is that for any particular investment you’re going to use, you better use the cheapest version of it available!
There’s no requirement that you have to use, say, an S&P 500 Index fund over a large-cap, actively managed fund. If you can validate that the active fund provides value to justify its cost, that’s fine. However, if you’re going to use an S&P 500 Index fund, you damn well better use the cheapest one that’s out there. Because by definition, all S&P 500 Index funds are trying to replicate the same index. So unless there’s some underlying fundamental flaw in how the index fund is constructed – meaning you think it’s not going to deliver on providing the S&P 500 Index returns – there’s really no excuse to take a completely commoditized solution, like an S&P 500 Index fund, and buy anything except the cheapest version of it.
And here’s the key point: the same is true for mutual funds.
In other words, in the context of a company like American Funds, there’s no requirement to use an S&P 500 Index fund instead of Growth Fund of America, despite the fact that the American Funds actively managed fund does cost a little bit more, because they have active managers who get paid. However, if you’re going to implement Growth Fund of America instead of the S&P 500 Index fund, there’s no fiduciary justification for using a higher-commission A share version of the fund when you could’ve use the T share version. There’s no justification for using the C share of the fund if you had access to the F share instead. There’s no excuse to use an F-1 share with the 12b-1 and sub-TA fees if you could’ve used the F-3 share instead.
Because again, by definition, it’s the same fund. It’s the same manager. It’s the same investments. The only functional difference is the distribution cost packed into the fund paid by investors to either the broker or the platform. As a fiduciary advisor, we will now have an obligation to find the lowest-cost version of that solution. Again, not necessarily the cheapest mutual fund, but the cheapest share class of that mutual fund for the client.
I realize that, in some cases, finding the lowest cost institutional share class can entirely obviate our compensation as an advisor. If you use the F-3 share class instead of the C share, you don’t get paid the way that you would for a C share. That doesn’t mean you have to work for free. It simply means you will need to form an advisory relationship with the client, in order to get paid the advisory fee directly from the client, and then you use the cheapest share class you can to populate the account while you get paid for what you’re going to get paid for.
The end result is that the total cost to the client might actually be the same. But now, we all use the same F-3 share class. No more F-1 share, F-2 share, C share, B share, and potentially no A share or T share. In other words, we’ll be going from a half a dozen different share classes, all the way down to one!