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What 12b-1 Should Mean to You

September 20, 1996

Mutual funds solve marketing problems in two ways.

One is to top the performance charts for a few years, as big returns cure all ills. The other is to ask existing shareholders to pay a few bucks to help lure new investors.

The first way is hard, which is why so many funds are adding or raising 12b-1 fees. A 12b-1 fee is an annual charge to cover a fund's marketing efforts. Typically, it is paid to whoever sells the fund--split between a broker or financial advisor, the firm handling the trade and the fund's management company.

New sales channels such as the funds networks offered by brokerage firms, fee-based advisory services and 401(k) plans are making 12b-1s nearly inevitable. Somebody has to pay to make a fund available in those ways, and that's where fund management thinks you come in.

There are 12b-1 fees at 57% of stock funds and 71% of bond funds, according to fund tracker Lipper Analytical Services Inc. Add to that a few percentage points more for funds with approved-but-inactive 12b-1 plans. (Even some funds without sales charges use 12b-1s; they can levy fees up to 0.25% and still be called "no-load.")

The fees cut directly into performance. A fund with a 0.25% marketing fee cuts its returns by that amount. In dollars, that's $2.50 per year for every $1,000 invested, enough to create a snit, but probably insufficient to change funds.

Before slapping you with marketing fees or raising current charges, funds must seek permission in the form of a proxy vote. Shareholders are on a big losing streak in those votes--no one recalls the last time an issue such as a 12b-1 plan was defeated, but consider such a proxy fair warning to reevaluate the fund.

"The problem with fees like this is that first you pay and then you find out if you got your money's worth," says Holly Hooper-Fournier, co-editor of the Mutual Fund Strategist newsletter. "So long as you get a great fund, the fee is worth eating and wouldn't frighten me away. But you'd be stupid to tell them to go ahead and take more money from you unless you were getting something extra in return."

Says Robert Powell, editor of Mutual Fund Market News: "I can't think of a single legitimate reason why a shareholder would vote for a 12b-1 fee."

In the last few weeks, shareholders in the GAM Funds were asked to approve a 0.30% marketing fee. The proxy recites the mantra every fund group uses to push through a 12b-1 fee: The funds must grow to remain viable; more money means efficiencies that should benefit investors--most notably that expense ratios--a percentage of assets in the fund--should decline as the fund grows. (The real plus from new assets is that they stabilizes a fund.)

Changing sales patterns--particularly brokerage "supermarkets" of funds and fee-only advisors--mean that a simple upfront sales charge isn't always charged, or that if it is, it isn't the popular way to collect fees.

The GAM prospectus clearly gives the impression that advisors will stick with a fund that rewards them relatively less only when it has superior performance. Once short-term numbers turn for the worse, advisors turn their customers to something that pays better.

Just because marketing fees aren't a good deal does not mean an investor should rush to the exit. Consider taxes. Next, weigh the total cost--the sum of the expense ratio plus any 12b-1 fee. (Remember, a fund with a 1.5% expense ratio takes more of your cash than one taking 0.75% for expenses and tacking on a 0.25% marketing charge.)

If the fund's overall expenses, including 12b-1 fee, are at or below average costs--currently 1.27% for stock funds and 0.97% for domestic taxable bond funds, according to Lipper, don't feel gouged.

Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at or at Boston Globe, Box 2378, Boston, MA 02107-2378.

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