Three Key Concepts for Understanding a Mutual Fund | Lord Abbett
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Practice Management

This video explains important concepts in the ever-changing asset management industry: mutual fund expense ratios, mutual fund share classes, and the role of a mutual fund board of directors.


ANNCR (VO): Welcome to Lord Abbett’s business building series titled “Three key concepts for understanding a mutual fund.”

In the ever-changing asset management industry, there are important concepts that may seem complex or unclear at first. We’re here to make those concepts easy to understand, so you can help your clients make better informed decisions for their financial future.

We’ll focus on mutual fund expense ratios, mutual fund share classes, and the role of a mutual fund board of directors. Let’s get started…

What is a mutual fund expense ratio? Simply put, an expense ratio is a measure of the ongoing cost for an investor to own a mutual fund. The expense ratio for each share class is calculated annually by dividing expenses by the average dollar value of its assets under management. These expenses may include a management fee for investment and portfolio management services…expenses for distribution and service of the mutual fund… as well as other operating expenses, such as custodian expenses, shareholder servicing and professional expenses. Together, these expenses make up the expense ratio, which can vary based on the terms of each share class. Some expenses are shared by all of these share classes, while others are not.

First, we have the management fee, which is common to all share classes. This fee compensates the investment manager for overseeing the portfolio. 

Next are “other” operating expenses, some of which may be common to each share class.

Finally there is the 12b-1 fee, which is the expense for distribution of the fund and to service its shareholders. Each share class’s 12b-1 fee varies, and not all share classes have a 12b-1 fee.

So what are mutual fund share classes? Many mutual funds offer multiple classes of shares to investors. Today, we will take a look at three broad types of share classes: Brokerage, Institutional, and Clean Shares. But what makes them different?

As the name suggests, brokerage share classes are used for brokerage accounts and often contain an upfront, or backend load, or sales charge.

Institutional share classes may be used by institutional investors or within retail fee-based accounts. Some Institutional share classes may not have a 12b-1 fee.

Finally, clean shares are a newer type of share class that are typically utilized in retirement and fee-based accounts.  These share are called “clean,” because they typically do not carry a 12b-1 fee or certain “other” expenses, such as sub-transfer agent or broker-dealer record-keeping expenses.

While there are many different share classes, it’s important to note that one share class isn’t necessarily better than another. So what drives the use of a particular share class?

Over the past few years, there’s been a shift in the way financial advisors do business, as many of them transition from a largely transactional or brokerage business model to a fee-based approach.

As more financial advisors change their business model, the availability of—and preference for—certain share classes may be impacted.

Ultimately, the decision of which share class is most appropriate for a client will depend on the financial advisor’s business model and the client specific situation.

Now let’s take a look at how mutual funds are governed.

According to the Investment Company Act of 1940, every mutual fund is overseen by a board of directors who are largely independent of the investment management company and represent the best interests of shareholders. Each year, the board of directors chooses whether or not to re-hire the investment management company—and utilize what is called the 15(c) process to determine if the fund’s fees are reasonable in light of the services provided. Typically, the board will re-hire the investment management company, but it’s important that the board ensures that the investment manager is acting in the best interest of the client. 

We hope we’ve clarified these concepts, and provided you with a better understanding of mutual fund expense ratios, share classes and the role of the board of directors.

If you need more information on these and important investment topics, visit Lord Abbett dot com slash advisor advantage.

The views and opinions expressed by the Lord Abbett speaker are those of the speaker as of the date of the broadcast, and do not necessarily represent the views of the firm as a whole. Any such views are subject to change at any time based upon market or other conditions and Lord Abbett disclaims any responsibility to update such views. This material is not intended to be relied upon as a forecast, research or investment advice. It is not a recommendation, offer or solicitation to buy or sell any securities, or to adopt any investment strategy. Neither Lord Abbett nor the Lord Abbett speaker can be responsible for any direct or incidental loss incurred by applying any of the information offered.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

Copyright © 2019 by Lord, Abbett & Co. LLC.  All rights reserved.


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