Attributes and Implications of Mutual Fund Revenue Sharing and “Defensive” 12b-1 Fees

Abstract

Revenue sharing rewards brokers for high and higher sales and/or asset holdings of fund shares, and further defrays current and higher broker costs of advertising and promotion, ongoing broker servicing of fund investor accounts, and educational support. It results in higher broker sales and increases fund assets under management (higher inflows) and profits; higher broker sales of fund shares increases sales concessions and distribution fees. Higher assets under management in turn increase trade size and broker commissions, trade execution, and profits. Revenue sharing usually brings direct payments from fund advisor “profits,” but may be bundled in fund management fees paid to advisors who write the checks. The use of management fees to pay revenue sharing increases fund fee size and fund outflows. Brokers rebate “fall-out benefits” from “excess” revenue sharing payments directly to fund advisors, which motivates higher revenue sharing payments and higher broker profits. Revenue sharing payments via management fees reduce current fund NAVs and shareholder returns. Most retail investors are unaware of the existence, nature, and costs of revenue sharing payments. Revenue sharing is agency conflicted with shareholder interests and returns.

TOPICS: Mutual fund performance, wealth management