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DOL Rule Is Dead, but Clean Shares Will Live On: Cerulli

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Clean shares that were devised to comply with the Labor Department’s fiduciary rule will live on despite the rule’s demise, Boston-based Cerulli Associates opines.

While clean shares have existed for some time, Labor’s fiduciary rule ushered in the advent of T shares (or “transactional” shares) and then share class Z, or “clean” shares — which were developed to allow level commissions that the broker could charge directly to the customer.

Cerulli notes in its report released Tuesday that these new share classes “were defined as a triple-zero or double-zero share class that would be designed specifically for the intermediary channel to address concerns over conflicts of interest.”

Now that Labor’s rule has been repealed, will the share class type “stick” within the intermediary channel? “There are reasons why it will,” the firm states.

Despite the death of Labor’s rule “and lack of clarity around the inclusion of sub-transfer agent (sub-TA) fees, clean-share mutual funds will likely have a place in the intermediary market due to greater fee transparency and lower cost,” Cerulli states.

Asset managers “will need to work hand-in-hand with their distribution partners to rework the payment flow of certain asset-based fees (e.g., 12b-1 fees, sub-TA fees) that will no longer be included in clean shares.”

What is a clean share? Cerulli explains that the share class falls into one of two broad classifications, commonly referred to as “double zero” or “triple zero.”

Double-zero share classes refer to those that do not contain a sales load, have stripped out distribution fees (e.g., 12b-1 fees), but do contain some kind of service fee or sub-transfer agent (sub-TA) fee.

Triple-zero shares also do not contain a sales load, have no embedded distribution fees, and carry no service or sub-TA fees.

“The reason these two definitions exist right now is due in large part to the lack of clarity on whether sub-TA fees can be included in a clean share class,” Cerulli states.

Cerulli identifies clean shares as triple-zero shares, “which fully isolate the management fee from all other distribution or sub-TA asset-based fees that are embedded in a product expense ratio.”

Based on data from recent Cerulli research, clean shares comprised an average of just 1.8% of the 2017 gross sales for asset managers.

“That percentage has ticked up slightly from 1.5% in 2016,” Cerulli says. “Despite the low figure, managers maintain a positive outlook for the share class’ future prospects, with 80% expecting increased use of the clean share over the next 12 months.”

Intuitively, Cerulli continues, “mutual fund managers should get behind clean shares, as they make the mutual fund more competitive with the exchange-traded fund. By unbundling the distribution and service fees from the management fee, the cost structure starts to resemble the ETF in some regards.”

Lia Mitchell, data content researcher at Morningstar, told ThinkAdvisor on Tuesday that the fund rating firm agrees that clean shares will survive. “There’s still a lot of interest” in them and ”there was a shift away from bundled share classes before Labor’s rule that we expect to continue,” Mitchell said. “How much that shifts to semi-bundled versus unbundled I don’t think we can clearly say at this point.”

Morningstar noted in a July blog post that while there’s still no common definition of “clean,” there is “universal agreement that clean shares will not have loads or 12b-1 fees, which are both fees used to pay for a mutual fund’s distribution costs.”

To help investors and the industry untangle what these new share classes mean, Morningstar “is labeling emerging share classes a little differently,” the blog states. “Although ‘clean’ may stick in the lexicon, the heart of our idea is to describe the service-fee arrangement and shed light on what an investor pays for whether it’s directly (say, by writing a check to an advisor) or indirectly (via a fund’s expense ratio).”

— Check out Are Low-Cost Mutual Funds Now Competitive With ETFs? on ThinkAdvisor.


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