A focus on fairness and fiduciary fitness is driving many investment product providers to implement R6 share classes and other institutional offerings with zero revenue sharing.
Overall, according to the August 2015 issue of The Cerulli Edge, nearly 60% of asset managers will make changes to share class offerings heading into 2016. In this group, a quarter plans to add share classes, “primarily cited as R6 or some zero revenue share class,” and a similar number will move away from share classes that generate revenue through commissions or sales fees.
The movement away from commissions and revenue sharing reflects regulators’ focus on fiduciary care and conflicts of interest. In some ways, Cerulli says the ongoing shift represents a return to a way of doing business that was more popular 20 years ago, before investment managers started offering an “alphabet soup” of different share classes.
Share classes diversified for a variety of reasons—partly because of advancing recordkeeping technology and an interest among providers in casting a wide net. Now the focus has shifted, Cerulli notes, and those paying higher fees are demanding better service and a better deal.
It’s also a matter of competition. Keeping with the trend toward low cost, flows “feverishly” moved into the cheapest share classes during 2014, Cerulli says. Institutional share classes captured $165.5 billion of inflows during the year, “eight times that of the next top-flowing share class (Retirement). Looking at flows moving into newly introduced share classes, this same trend continues.”
Cerulli’s findings come from an analysis of the 50 largest asset managers, based on mutual fund assets under management as of year-end 2014. At a high level, Cerulli says there appear to be “tiers of share classes among this universe of firms.”
NEXT: Share class breakdown
The first tier includes institutional shares, A-shares, retirement shares and C-shares.
“This first tier is offered by more than 70% of the top-50 firms,” Cerulli finds. “Between 30% and 70% of firms also offer the second tier of share classes, which includes no load, B-shares, R6, and an investor share class.”
The third tier comprises an “amalgamation of share classes,” Cerulli says, including adviser, S, N, D, T, and M. “These shares are offered by less than 30% of the top-50 firms.”
Investment providers adding new products seem to be favoring the first tier, as most newly introduced share classes were institutional (470) and retirement (379) in 2014. According to Cerulli, A-shares and C-shares also experienced triple-digit share class introductions.
“Flows for these new share classes were mostly in institutional, accumulating $17.5 billion in 2014, representing 56% of total net flows,” the report says. “Cerulli believes eventually there will be a shake-out of share classes, leaving asset managers with just a few core share classes—a low-cost institutional share class, a share class for retail platforms (typically 40 basis points), a classic 25-basis-point 12b-1 share class, and a bare-bones retirement share class.”
Another important theme highlighter for the retirement market: plan sponsors are looking to separate the fund cost from the revenue “so that the right individuals—and not necessarily the end investor—are paying.”
“Originally, the industry expected to see an increase in the use of collective trusts for defined contribution (DC) plans in light of the intense scrutiny around plan costs, but mutual fund providers responded by creating either a zero-revenue-sharing share class, or a share class with embedded sub-TA fees and zero 12b-1 fees,” Cerulli explains. “R-share class 12b-1 is designed to cover compensation of an adviser or a third-party administrator of the plan. Given the Department of Labor's focus on fee disclosure and transparency, the use of revenue sharing is generally on the decline.”
NEXT: Tough year so far, across share classes
Cerulli finds that trends have shifted somewhat during 2015, and increased favorability for transparent fee structures has not translated to unbridled momentum for passive investments and the lowest-fee products. The Cerulli analysis shows low-fee, passive institutional strategies experienced “significant outflows in 2Q 2015.”
Outflows from passive products were strong enough for Cerulli to declare that, while no one can know the future of asset flows, “the framework of the active/passive debate will change from an either/or proposition to how both approaches can be used in more customized, objectives-based multi-asset-class strategies.”
Even before the most recent round of volatility spooked investors, the second half of the year had kicked off on a sour note for mutual funds, according to Cerulli’s research.
Mutual funds “bled nearly $11 billion during July,” dragging the year to date inflow total down to $113.7 billion. Asset figures still increased in July due to positive equity market movements, with mutual funds ending the month up 0.1% at $12.5 trillion. Cerulli finds exchange-traded funds (ETFs) closed July up 1.4%, reaching $2.1 trillion after a dip in June.
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