The “clean shares” movement evokes thoughts of mutual funds stripped of commissions and other third-party payments to brokers, advisors and other intermediaries—but the truth is somewhat messier.
So-called “clean shares” do leave behind loads and 12b-1 fees, but may still contain sub-transfer agency fees, or “sub-TA” fees, and other types of revenue sharing between a fund’s advisor and intermediaries, according to Chicago-based Morningstar.
“The term has a certain connotation, an idea of purity and betterment,” said Lia Mitchell, a data content researcher with Morningstar. “What we’ve found is that there is not a set hierarchy where one share class is always inherently better than the others. It really does depend on the investor and what they’re looking for.”
In lieu of the all-encompassing clean shares terminology, Moningstar proposes new classifications of mutual fund expense models: bundled, semi-bundled and unbundled.
Traditional, bundled share classes would include loads, commissions, distribution fees, transaction fees and other operational fees. Bundled shares would most closely resemble the types of share classes offered by most advisors working within a brokerage model.
Semi-bundled shares would lose the distribution or 12b-1 fees, as well as loads, commissions and transaction fees, but retain revenue sharing arrangements and sub-TA fees. While some firms refer to these share classes as clean shares, Morningstar argues that investors are confused by the designation.
“It’s not that having a sub-TA fee or revenue sharing is necessarily bad, but it creates different conflicts that investors should be aware of,” said Mitchell.
Mutual fund shares in an unbundled expense arrangement would require investors to pay for management fees and fund operating expenses, but nothing else. These share classes would fit what most investors likely think of when they hear the term “clean shares.” In almost any case, unbundled share classes would be preferable for use in defined-contribution plans like 401(k)s, according to Mitchell.
The clean shares designation is a recent import from Europe, gaining traction in the U.S. in 2016 and 2017 as asset managers and advisors prepared for the impact of the now-vacated Department of Labor fiduciary rule. In 2017, the U.S. Securities and Exchange Commission gave clean share classes its approval, but did not provide much information on them. In the SEC’s ruling, payments to intermediaries could still be included in part of a clean share class’s fee structure.
“The term ‘clean’ is too complicated and I don’t think it’s clear to investors. That’s why we think there’s a need to move to more descriptive terminology,” said Mitchell.