Morningstar Magazine - June/July 2018 - 20

Dispatches

EXHIBIT 1

A New Way to Label Share Classes These new categories better describe
service-fee arrangements between asset managers, distributors, advisors,
and investors.
Unbundled

Semibundled

Bundled

Management Fee
Fund Operating Expenses
Subtransfer Agency Fees
Revenue Sharing, Platform, or Other Access Fees
Distribution Fees (12b-1)
Loads and Commissions
Transactions and Other Operational Fees
Fees for Advice or Planning
Source: Morningstar.

and its advisor do not pay third parties who sell
their funds to the public.
Semibundled
No traditional distribution fees (or 12b-1 fees)
or load-sharing but can have revenue sharing
or sub-TA fees.

should always ask their advisors: Are they
acting as a fiduciary, as someone who puts their
clients' interests ahead of their own?

What Do They Mean for Investors?

Unbundled share classes reduce conflicts,
but investors still need to ask if they are paying
a reasonable amount for advice and for
the services that their intermediary charges them
directly. For example, investors in unbundled
share classes may be in a wrap account, where
they pay a percentage fee to cover all administrative and management expenses and
do not pay a commission when they rebalance.
These arrangements may not be appropriate for
every investor, and often cost 1% or more
of assets under management each year. However,
investors in 401(k) plans will almost always
be better off with unbundled share classes, all else
equal, as they represent the cheapest way for
them to invest.

The unbundled and semibundled categories
are not necessarily the best for every investor.
Rather, each of these service arrangements
can be appropriate for different kinds of investors.
In fact, the unbundled share class could
end up costing investors the most. Each type
of service arrangement also raises different
questions investors should ask their
advisor. And whatever the type of service-fee
arrangement, there is one question clients

Semibundled share classes could create some
potential conflicts of interests that investors need
to ask about. For example, these arrangements
can be the deciding factor for a fund to get
onto an intermediary's platform. Further, if funds
vary in how much revenue sharing they
pay to intermediaries, it could create incentives
for advisors to push one fund over another.
Investors should ask if advisors or their firms have

Bundled
Traditional share classes, where the investor
pays a load and a 12b-1 to the mutual fund, which
in turn pays the intermediary.
Users of Morningstar Direct and Advisor
Workstation will begin seeing these
new labels soon for all U.S. funds at the share
class level under "Clean Share-Service
Fee Arrangement."

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Morningstar June/July 2018

taken steps to mitigate these potential conflicts
of interest. For example, some firms say that
all funds on their platform pay the same amount
for sub-TA and revenue sharing, reducing
conflicts of interest. Investors should also ask
about which funds are not on the platform-
and why. Many retail investors will increasingly be
offered semibundled share classes instead
of bundled share classes. If firms mitigate any
conflicts these can create, they can work well for
many retail investors.
Bundled share classes are purely transactional,
which can work well for sophisticated investors
who have done their homework and wish
to pay up-front commissions. Advice associated
with these share classes may ultimately
cost less, particularly with rights of accumulation.
Investors should ask themselves how much
they understand about their advisor's
compensation and whether they have scrutinized
recommendations. Selling funds with loads
has been a practice in long-term structural
decline, but that arrangement can be best for
some investors.
Promising Innovation

While the momentum toward clean and
unbundled share classes slowed a bit this year,
we expect it to rebuild, and we welcome
that trend. That said, these promising innovations
are not standardized, and one version won't
necessarily be best for all investors. Our system
of evaluating and classifying each share
class according to its service-fee arrangement
will help investors and advisors make bestinterest assessments. K
Aron Szapiro is director of policy research with Morningstar.
Janet Yang, global data director, core managed
investments, with Morningstar, and Lia Mitchell, a data
content researcher with Morningstar, contributed
to this article.
Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2018
