A recent Ignites article explored the desire within the fund industry to implement flexible pricing structures for mutual funds, similar to those used by collective investment trusts (CITs) and separately managed accounts (SMAs).
In recent years, vehicles such as CITs and SMAs, which can offer asset-based or negotiable prices, have picked up market share from mutual funds, which have set prices based on their share class.
Many within the fund industry are eager for mutual funds to get to play by the same rules and be allowed to charge differential fees for the same share class. But according to the Investment Company Institute (ICI), which strongly supports such a rule change, the SEC has no interest or intention to address mutual fund fee differentials at this time.
SEC Remains Uncomfortable with Fee Differentials
The SEC’s seeming unwillingness to allow for a similar pricing structure for mutual funds shouldn’t come as much of a surprise, considering its release of a bulletin earlier this year that cautioned mutual funds and their boards of directors about implications of differential fee waivers under the Investment Company Act of 1940.
Earlier this year, the staff of the SEC’s Division of Investment Management issued a bulletin cautioning mutual funds and their boards of directors about potential implications under the Investment Company Act of 1940 when fee waiver and expense reimbursement arrangements cause different advisory fees to be charged to different share classes of the same fund—referred to as “differential advisory fee waivers.”
The bulletin acknowledges that Rule 18f-3 allows fee waivers and expense reimbursements, as long as those arrangements do not result in cross-subsidization of fees among classes.
However, it emphasized that fee waivers and reimbursements were not intended to become “de facto modifications.” Differential fee arrangements should not be long-term or serve as permanent provisions without periodic checks to ensure they continue to be judicious.
One principle underlying Rule 18f-3, as expressed in the bulletin, is that advisory fees charged to all classes of a fund should “generally be the same percentage amount” since shareholders receive the same advisory services regardless of class. Based on that principle, the bulletin identifies long-term or permanent differential fee waivers as possibly creating a means of cross-subsidization among classes, which is in violation of Rule 18f.
Disagreement in Industry on Flexible Fund Pricing
Not everyone is in favor of the proposal for flexible fund pricing, though. Many in the industry cite concerns that having different fees within the same share class, and thus different NAVs, would cause too much confusion and complexity for shareholders.
An alternative approach to fund pricing flexibility is for funds to take advantage of the expired Vanguard patent and offer ETF share classes within a mutual fund.
Until May of this year, Vanguard held the patent for ETF share classes of mutual funds, which essentially enabled it to offer both traditional mutual funds and ETFs as different share classes within the same fund.
For more than two decades, Vanguard held exclusive rights to structure ETFs as a distinct share class of their existing mutual funds, but with the expiration of this patent, the gates are now open for other investment firms to adopt this once-proprietary structure.
While the industry seems to be split on the best way to approach fund pricing flexibility, it’s clear that the rise of vehicles like CITs and SMAs has catalyzed the potential for significant changes and a transformative shift in the dynamics of the fund industry.
Contact Delta Data to learn more about what this could mean for mutual fund operations.
Article by Burton Keller