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WALL STREET, CALIFORNIA | MUTUAL FUNDS / JERRY MORGAN

'B' Side Investors May Play a Little Longer

Some experts think the rear-end loads act as a disincentive to sell when a market heads south. But one thinks brokers' advice is a greater factor.

March 04, 1997|JERRY MORGAN

For the last couple of years, as investors threw hundreds of billions of dollars into stock mutual funds, many bought shares with "rear loads" from their brokers because they didn't want to pay upfront commissions.

Now, as many worry that a correction is starting or at least overdue on a long bull market, there are some who believe that investors holding rear-load shares, also called "B" shares, might be more likely to ride out a bad time than those who paid upfront.

"A" shares are the same portfolio of securities, but the commission is paid as a front load, reducing your investment by the amount of commission paid at purchase. For example, a $10,000 investment with a 5% commission would put only $9,500 to work for you.

With "B" shares, known also as contingent-deferred sales-charge shares, there is no upfront commission, so the entire $10,000 would be invested right away. But if you withdraw the money within a specified period, you pay an exit fee, based not only on your initial investment but also on any earnings. That commission often runs 6% if you withdraw in the first year, 5% in the second, then 1 percentage point less in each subsequent year. This acts as an incentive for people to stay in the funds. There are "C" and "D" shares, which have other wrinkles, but they are less common.

A major reason for the growing use of share classes is that brokerages and funds that charge high sales charges need ways to compete with the growing numbers of "no-load" funds that do not levy such charges. Some "B" shares can be essentially no-load if held long enough.

"Some of the data indicates that after the [1987] crash, B-share retention was pretty good," said Jessica Bibliowicz, executive vice president in charge of Smith Barney Mutual Funds. "It seems that investors didn't want to pay a commission on top of losing money, and they stick around. It is a source of discipline."

Bibliowicz said "B" shares, which account for about 10% of all mutual fund money, are attractive primarily because "investors don't want to pay upfront commissions. They want to see all their money go to work."

Joseph Clinard, a broker and financial planner in Melville, N.Y., and a partner in North Shore Capital Corp., said he urges clients to buy "B" shares for precisely that reason. "Psychologically, people don't want to see their money reduced by sales charges before they invest," he said. "And the B share money is there to stay and it is for longer terms."

That might be one reason. But Louis Harvey, president of Dalbar Inc., a Boston publisher that conducts mutual fund industry studies, said a survey on why people with "B" shares stayed in bond funds longer than those who held "A" shares during the 1994 bond fund debacle found that "the broker, not the investor, was the driver. It is really up to the broker to advise an investor to stay in. I don't know that being in B shares and facing a commission was a deterrent to getting out.

"The conclusion we came to," Harvey said, "was that it seemed to be the broker's mind-set. Those who sold A shares seemed to have more of a trading mentality. Those who sold B shares sold them to investors who were more conservative, and they held them longer."

The difference for investors between A and B shares works this way: If you have $10,000 to invest and you buy a front-load fund with a 5% commission, you will invest only $9,500. If, in 1995, that fund grew 22% and then 19% more last year, that $9,500 would have grown to $13,792, a $4,292 gain. But $10,000 in "B" shares, fully invested, would be worth $14,518, a gain of $4,518.

However, if you had decided to clear out at the end of 1996 because you felt the market was going south, you would have paid a 5% commission on the "B" shares, which would be $726, not the $500 charged as the front-end commission. That is because the commission is based on the value of all your assets, including investment gains. So the commission is based on the whole $14,518, not just the $10,000.

How much would you end up with? Excluding the fund's expenses, you'd have $13,792, the same as with the front load. But you'd probably have paid more in expenses, too, since the 12b-1 marketing fee for "B" shares is about half a percentage point higher than for "A" shares.

Clinard pointed out, as did Bibliowicz, that there is a common way around the rear-end commission for "B" shareholders who decide to get out of equities: Transfer the money into the same fund company's money market or bond funds. There'll be no commission in that case because it is an exchange, not a redemption.

Keep in mind, however, that exchanges from fund to fund still involve a sale, which means you will owe tax on any profits. Consider it Uncle Sam's rear-end commission.

Jerry Morgan writes for Newsday in Long Island, N.Y. He can be reached via the Internet at morgan@newsday.com

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