12b-1 Fee

The prospectus for the Halverson Growth Fund lists a 0.75% 12b-1 fee in the table of annual fund operating expenses. A 12b-1 fee is:

1. A.An annual asset-based charge deducted from fund assetsCorrect - ongoing asset-based fee.
2. B.A redemption penalty onlyA CDSC or a short-term redemption fee is charged on the way out; a 12b-1 fee is charged every year the shares are held. It is deducted from fund assets to pay for distribution and shareholder servicing, whether or not anyone redeems.
3. C.A government taxThe name comes from an SEC rule number, which makes it sound like a government levy. No tax authority receives any of it: the money is deducted from fund assets and paid out for distribution and shareholder servicing.
4. D.A one-time front-end loadBoth are ways of paying for distribution, so they are cousins, but the timing is the distinction. A front-end load is taken once at purchase, while a 12b-1 fee is assessed annually against assets for as long as the shares are held.

Why: A 12b-1 fee is an annual asset-based charge deducted from fund assets for distribution/servicing.

Delia Okonjo notices that the Marston Equity Fund quotes a public offering price of $18.42 and a net asset value of $18.42, and its prospectus shows a 0.20% 12b-1 fee. A no-load mutual fund:

1. A.Always outperforms load fundsAvoiding a sales charge does leave more money invested from day one, so the cost advantage is genuine. Results still depend on what the portfolio owns, and a well-managed load fund can outperform a no-load one; the word always is what makes this false.
2. B.Cannot be redeemedWhether a fund charges a load has nothing to do with redeemability. A no-load fund is still an open-end investment company, so it stands ready to buy shares back at the next computed NAV.
3. C.Charges the maximum 8.5% loadThis states the direct opposite of the term. A fund charging the maximum permitted load is the most heavily loaded fund the rules allow, while a no-load fund sells shares at NAV with no sales charge.
4. D.Sells shares at NAV with no sales chargeCorrect - no front or back load.

Why: A no-load fund sells shares at NAV with no sales charge (and any 12b-1 fee is 0.25% or less).

Reviewing the fee table of the Wexbury Balanced Fund with a customer, a representative points to the 0.94% total annual fund operating expense figure. That percentage includes the management fee, the 12b-1 fee and other operating expenses, but it does NOT include:

1. A.custody and transfer agency costs, which the adviser always absorbs.Those are ordinary fund operating expenses and are included.
2. B.the 12b-1 fee, which is charged against distributions rather than against assets.The 12b-1 fee is an annual asset-based charge and is included in the ratio.
3. C.the fund investment advisory fee, which is disclosed only in the statement of additional information.The advisory fee is the largest component of the expense ratio and appears in the fee table.
4. D.front-end sales loads and contingent deferred sales charges, which appear separately as shareholder fees.Correct. Sales charges are shareholder fees, not annual operating expenses.

Why: The expense ratio measures the recurring costs deducted from fund assets each year: the advisory fee, any 12b-1 distribution and service fee, and administrative costs such as custody, transfer agency, audit and legal. It excludes one-time transaction charges paid by the shareholder, namely front-end sales loads and contingent deferred sales charges, which appear in the separate shareholder fees section of the table. It also excludes the brokerage commissions the fund pays to trade its portfolio, which are absorbed into the cost of the securities.

Cordelia Wren bought Class B shares of a mutual fund seven years ago. The contingent deferred sales charge schedule expired last year, and the fund prospectus provides that Class B shares convert to Class A after the deferred charge period ends. She asks her IAR what the conversion accomplishes. What is the correct answer?

1. A.It refunds the contingent deferred sales charges she paid over the earlier years of her holding period.Incorrect. Conversion is forward looking. It does not refund charges already incurred, and in her case no deferred charge was paid because she held past the schedule.
2. B.It is treated as a redemption of Class B shares and a purchase of Class A shares, so she realises any gain in the year of conversion.Incorrect. A conversion between share classes of the same fund is not a taxable disposition and does not restart the holding period.
3. C.It converts her holding into a no-load fund with no ongoing distribution fee of any kind.Incorrect. Class A shares typically still carry a 12b-1 fee; it is simply lower than the Class B fee. Conversion reduces the fee, it does not eliminate it.
4. D.It moves her into the share class with the lower ongoing 12b-1 fee now that the deferred charge period has ended, improving her net return going forward, and it is not a taxable event.Correct. The higher Class B distribution fee has no continuing justification once the CDSC schedule has run, and the exchange within one fund is not taxable.

Why: Class B shares are sold without a front-end load. The distributor recovers its selling costs in two ways instead: a contingent deferred sales charge payable if the investor redeems within a stated number of years, declining to zero over that schedule, and an ongoing annual 12b-1 fee that is materially higher than the fee on Class A shares. Once the deferred charge schedule has run its course, the distributor has been fully compensated, and there is no longer any justification for continuing to levy the higher ongoing fee. The conversion to Class A therefore lowers the shareholder ongoing expense ratio going forward, which directly improves net return for the remaining holding period. The conversion is effected within the same fund at net asset value and is not a redemption and repurchase, so it is not a taxable event and does not start a new holding period for capital gains purposes. Where a fund fails to convert eligible shares on schedule, investors are overcharged, which is why the conversion feature receives regulatory attention.