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Saturday, June 2, 2012

Dealing With Class C Shares

My present project is converting a portfolio of high-fee C class share funds to low-cost exchange traded funds.  The class of mutual fund shares determines when and what and how fees are charged.  To completely understand the fees associated with various classes, you practically need a PhD in Physics.  This is by design.  It is one of the main reasons for the strong growth of exchange traded funds.

Let's look at an example to understand what these C share funds are.  The client holds BMECX--a "BlackRock US Opportunities" fund.  Put the ticker into Morningstar and find:

Source: Morningstar
CLICK TO ENLARGE  Note the arrows. You can easily see in the title that it is a class C share fund.  This typically means there is a sales charge (a load) of 1% if the fund is sold before holding for 1 year.  Don't ask me how they get away with this.  If you don't like the investment after 9 months and want to sell it, they charge you!  It is worth noting that one of the very first academic findings was that load funds do not outperform no-load funds.  Still they persist.

The expense fee on "C" shares are higher than average.  For load funds (i.e. sales commission funds), you either pay in the beginning, the end, or as you go along.  On this particular fund, the ongoing annual expense is 2.24%!

Note also the high rate of turnover at 120%.  Turnover is defined as sales divided by total value of the fund.  Thus, the entire fund was more than essentially replaced over the previous 12 months.  Trading detracts from performance, even in an environment of low commissions, when it is occurring at this level.

At the Morningstar site, click "performance" and you get:

Source: Morningstar
CLICK TO ENLARGE  Note that the fund is classified as MG (mid Cap Growth) and yet is compared to the S&P 500.  This is obviously not an apples-to-apples comparison.

The fund did well in 2007, 2008, 2009, and 2010 relative to the S&P 500 and relative to its group in the first 2 years.  It was definitely an easy sell (to a potential client) in 2009 and 2010.  But how did it do versus a low-cost, mid Cap growth ETF?  Consider the Vanguard Mid-Cap Growth ETF (VOT).  Put VOT into Morningstar and you find the fee is 0.10%.

Next, start with BMECX again, click performance and in the "compare" box put in VOT.  Also, in the box "add index" pick Morningstar's Mid-Cap index.  This still isn't apples to apples, but it is closer. The annualized return results you get are summarized in the following table.

         1 Year      3 Year      5 Year 
BMECX -15.04 9.35 -0.35
VOT -9.01 15.94 -0.37
Mid-Cap Index -7.25 15.97 -0.71
Rank in Category 92 94 50

The "Rank" is for BMECX.

A couple of points to note.  Over 5 years, the load fund matched the indexed ETF.  This indicates it had some pretty good years because it has not done well over the past 3 years.

This reveals an important message.  There are periods where load funds, despite the fees, will do well. The managers, after all, are usually really smart and have tremendous resources at their finger tips.  The problem, though, is that in the long run, as they are extracting a much higher fee than the index ETFs, they face strong headwinds.

At best, only 2 out of 10 will come out ahead over a 10-year period.  This is what the unbiased academic research finds in study after study.

Disclosure:  This post is for educational purposes.  Individuals should do their own research or consult a professional before making investment decisions.


  1. Class C shares ---- run the other way as fast as possible....... and in general stay away from fund families with multiple classes of shares because odds are high you are being ripped off.

    1. This should get a chuckle: this account comes to me from one of the advisors listed high on Barron's list of "The Top 100 Women Financial Advisors".

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