The Coming Armageddon Of Annuity And Mutual Fund Share Classes

The Coming Armageddon Of Annuity And Mutual Fund Share Classes

Because of these fiduciary dynamics, I think we’re about to see a total collapse in the confusing number of share classes that exist today in the mutual fund and annuity arenas. At least, once DoL fiduciary actually goes through. I know it’s still up in the air about whether it’s just going to get delayed. But it currently looks like even if it does get delayed, it’s probably going to be modified or softened a little bit, but not necessarily repealed or rescinded. And as long as that core fiduciary requirement remains, every share class besides the cheapest one will quickly become irrelevant. Or become a lawsuit waiting to happen!

My guess is that we’ll find within just a year or two, mutual funds are probably going to come down to maybe two share classes. T shares for those that still do some kind of upfront commission business – so they can still get paid their 2.5% commission – and then some kind of institutional class advisory share, such as an I share or an F-3 share in the case of American Funds… with no commissions, no 12b-1 fees, and no sub-TA fees. The cheapest version of the raw investment that you can get, and then the advisor layers their advisory fee on top as appropriate. Because, if it’s meant to be an advisory share class, it’s virtually assured to be a fiduciary breach to use a share class with all of those additional costs when there’s an alternative that doesn’t have them.

Again, this doesn’t necessarily mean a collapse in advisor compensation, because you can still use advisory accounts with institutional share classes and charge your own advisory fee, instead of getting paid, say, 1% through C shares. And at least for some period of time, I suspect we’re going to continue to see T shares in place as well.

But I do think we’re going to see A shares quickly vanish in lieu of T shares. I also think we’ll see C shares quickly vanish in lieu of institutional class shares. And I think we’ll see similar scrutiny on retirement share classes and 529 share classes. Variable annuities will probably also come down to a core of two alternatives: one with a moderate upfront commission, and the other one that’s simply a fee-based contract.

It’s worth noting that the share classes probably aren’t going to vanish right away, in part because while DoL fiduciary is the catalyst that drives this, it still only applies to retirement investors. Which means, it only applies to retirement accounts, and advisors will still be able to use all those other share classes in non-retirement, taxable investment accounts, as well as for nonqualified annuities. But ultimately, I think it’s only a matter of a few years before eventually the SEC acts with its own fiduciary rule – if only to bring parity to the DoL fiduciary rule and get a level playing field. Then, the same rules really will apply for retirement and taxable accounts.

And there have already been a lot of broker-dealers saying they’re putting their changes in compensation in place uniformly across the whole platform now. As a result, the share classes that’ll be available are going to be the same for both DoL fiduciary retirement accounts and the rest. Because, otherwise, you’re kind of begging for a lawsuit against you if a lawyer ever sees that the client’s non-retirement accounts have more expensive versions of the exact same fund that you’re already using in their retirement account in a lower-cost alternative. For your own protection, it behooves you to be consistent across the board!

Which means, I think it’s only a matter of time (and it may not even take that much time), to see a total collapse in the huge number of share classes that exist today. Fund companies that have 16 share classes will probably be down to probably just two: a version with some upfront commission for brokers who sell them – like the new mutual fund T shares – and then the lowest-cost possible institutional or advisory share class, where the advisor would be expected to layer their own advisory fee on top.

Which, effectively, will complete our transition from getting paid 1% as levelized commissions, into getting paid 1% as an advisory fee for advisory services – in essence, the shift from being brokers who sell products, into advisors who actually sell advice.

In any event, I hope this provides some food for thought about how the proliferation of mutual fund and annuity share classes that has been underway for the past decade is probably soon going to go through a very sharp reversal and decline!

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