The invisible race to zero
In wealth management, the “race to zero” usually refers to disappearing trading commission fees at giant custodians and retail brokerage firms like Charles Schwab, TD Ameritrade and Fidelity Investments.
However, mutual fund fees of all types have also been shrinking — or even zeroing out. And along with the lower costs, mutual fund commission load payments to broker-dealers have fallen off a cliff.
How far? Under an SEC rule that changed fund companies' mandatory disclosure forms earlier this year, it’s no longer possible to say.
The rule in question altered most large funds’ quarterly and annual disclosures by eliminating the requirement to list the amount of load-sharing kickbacks. As a result, researchers and policymakers can no longer assess their relationship to fund flows or returns.
Financial advisors and clients can find the amount of their specific commission loads from a fund’s prospectus. But even as the SEC places disclosure at the center of recent enforcement cases and its Regulation Best Interest, it no longer tracks aggregate commission loads.
“You don’t want to collect irrelevant data points or data points that are historical artifacts, but this one still seems pretty relevant,” says Aron Szapiro, Morningstar’s director of policy research. “You can't evaluate what you can't measure and, right now, nobody can measure this.”
Under a 2016 rule that’s still gradually taking effect, large funds are filing Forms N-PORT and N-CEN rather than Form N-SAR, which Morningstar and other researchers previously used for load data. At least six items on the form relating to loads are no longer required, the rule states.
The information “has been found by interested third parties, including researchers, to be important in their analysis of the fund industry,” the regulator said in a footnote in the final version. The text cites a 2013 study linking excess loads to higher flows and lower returns.
“We have attempted to mitigate the potential cost relating to the loss of information by eliminating only those items which are either available elsewhere, not frequently used by Commission staff or provide minimal benefit relative to the burdens of reporting such information,” the rule states in a section outlining the potential cost of the rule.
Representatives for the SEC didn’t respond to requests for further comment concerning its stance on removing the load-sharing disclosure requirement.
The available data illustrates how advisors and clients have been choosing funds without any upfront sales charge or other types of loads. Commission loads have also been vanishing amid larger downward pressure on fees of all types and traditional sources of BD revenue.
Average load-sharing payments to third-party intermediaries plummeted to 88 basis points in 2017, from 156 bps in 2010 and to 25 bps from 89 for captive BDs, according to a 2018 study by Morningstar. The research firm also found a positive relationship between loads and fund flows.
Meanwhile, share classes with front- or back-end loads sustained outflows of a combined $1.2 trillion since 2009, the Investment Company Institute’s annual fact book shows. The percentage of long-term mutual fund assets in load share classes shrank to 12% from 24% over a decade.
In that time, the proportion without front- or back-end loads and 12b-1 fees of 25 bps or lower surged to 71% from 55%. Still, the amount of net assets held in load share classes constitutes more than $2 trillion, and upfront sales charges often amount to 5% or more for Class A shares.
ICI attributes the contrasting flow data to the long-term shift away from commissions and toward asset-based fees. Sales in the 401(k) channel, as well as DIY investors who are increasingly weary of fees, have also played a role, the fund company trade group says.
“The SEC’s disclosure and reporting regime is comprehensive and places appropriate emphasis on items of greatest importance to retail investors,” said Matthew Thornton, ICI’s assistant general counsel, said in a statement. “The fund prospectus in particular provides detailed information about fees and expenses that individual investors pay, including any applicable sales loads.”
In its economic analysis of the fiduciary rule, the Department of Labor included lengthy discussion of how loads hurt returns. The positive relationship between flows and loads also became statistically insignificant after the rule was proposed in 2015, according to Morningstar.
Class A, B and C shares with loads of varying types are have suffered outflows amounting to several hundreds of billions of dollars annually in each of the past five years. But even if the aggregate load-sharing data makes a comeback, it could be impossible to quantify Reg BI’s impact on these kinds of commissions, Morningstar’s Szapiro says.
“It's a very useful metric and heavily studied,” he says, noting the role of the data in the analysis for the now-vacated fiduciary rule. “That was a key piece of data they were looking at. And now we don’t have that.”