When Investing Meets Revenue Sharing: Part 3

Part II of this article discussed how investment expenses are divided between the fund family that runs the fund and the recordkeeper that provides administrative services when the fund is offered within a 401(k) plan. We also discussed the fact that sharing revenue is often a requirement if a fund is going to appear in a 401(k) menu. Those funds that refuse to share revenue with the recordkeeper face an uphill battle as overall expenses for the employer, and the participants, may increase if their products are included.

This discussion has already taken a turn for the complicated, but I’m afraid we have to take it one step further to truly grasp the inner workings of this process. In this final installment, we’ll look at how fund companies actually tailor the expenses of their funds to provide differing levels of revenue for their recordkeeping partners.

In the graph below, we again look at our hypothetical investment in Bond Fund Class A. This time, we also take a look at the sister funds of Bond Fund Class A: Class D, Class Admin and Class Inst. You may not have given it much thought, but these letters and acronyms represent important differences (keeping in mind that this fund doesn’t exist and is merely an example).


As discussed previously, the total expense in Class A of our fund is 1.0%. The “Institutional” class of this same fund – shown here as Class Inst. – is run by the same management team and invests in a portfolio that is identical to that of Class A. The Class Inst., however, has total expenses of only 0.45%.

There are two ramifications of this decrease in fees. The first is that individuals who own Class Inst. pay less than half of the operating expenses that I do in Class A. In Part I, we discussed how a 10% gross return for Class A represented a net return of 9% for me and the other shareholders. Investors under this same scenario in Class Inst. would actually reap a return of 9.55%. Less operating expenses equals more return for investors.

The other important difference between the two funds is found in the revenue sharing. In Class A of the fund 0.45% (nearly half the operating expenses) is paid to Recordkeeper EFG. In Class Inst., however, only 0.10% of revenue sharing is generated for Recordkeeper EFG.

This is a dramatic difference in revenue by percentage, but this difference is amplified many times over when 401(k) plans with millions in assets have to choose between these different share classes. For example, a $10 million investment in Bond Fund Class A generates $45,000 in revenue sharing. That same $10 million investment in Bond Fund Class Inst generates only $10,000 in revenue.

As of January 2008, information on revenue sharing is not legally required to be disclosed to the employer or the participants within the plan. Both Congress and the SEC have suggested that some level of disclosure take place. I agree.

*Originally published February, 2008.

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