Have you heard about “clean” shares? They’re the coming thing (see “What a Fiduciary Should Know: Down and Dirty with ‘Clean’ Shares,” FiduciaryNews.com, October 10, 2017).
You can’t turn to a financial magazine or retirement industry media site without reading about “clean” shares. They’re everywhere! They’re everywhere! In fact, chances are you’re afraid you may have missed the train on this one.
Don’t worry. You haven’t. Here’s what they’re not telling you.
It’s not that the train has left the station – it has. Only thing is, it left the station years ago. Decades ago.
On the face of it, “clean” shares are being touted as the wave of the future. The fact is, they’re as much a part of the future as steam locomotives are. Here’s why.
If we are to accept the strictest definition of “clean” shares, then we’re talking about mutual funds that have no loads, no 12b-1 fees, and no revenue sharing. In an industry that’s dominated by the sales culture (not that that’s a bad thing), it’s rare to find a mutual fund that isn’t tainted by the stain of any one (or all) of these three titans of conflict-of-interest fees.
The entire mutual fund biosphere is predicated on the existence of these fees. They're woven into the very fabric of the traditional retirement plan infrastructures, and service providers throughout the realm have learned to survive (and thrive) with business models predicated on these “unclean” fees.
If that sounds judgmental, don't blame me. Blame the promoters of “clean” shares. For in order to sell the concept of “clean” shares, one must presuppose that the current world contains “unclean” shares.
But this essay isn’t about what makes a share “unclean,” it’s about that proverbial train. The one I mentioned earlier. That one that left the station sometime in the last century.
This is about those mutual funds that already have “clean” shares. They’re real, but they might as well be ghosts. It’s a violation of their ethos to do what is necessary to join their soiled brethren at the table of retirement plan products. For once they breach that vow against conflict-of-interest fees, it becomes a slippery slope upon which there is only one direction: down.
Here’s where the real temptation lies: Of the three legs upon which the conflict-of-interest stool rests, two of them are easily avoided.
Many funds have found a way around commission loads and 12b-1 fees. Historically, the loads left the table first. It’s taken longer, but today fewer than 10% of retirement plan funds have 12b-1 fees. So, it’s relatively painless to remove these two legs.
It’s the third leg, though, that has proven most diabolical. Such a temptress it is that even the SEC has yet to definitively address its very presence. On the pages of every mutual fund prospectus, the SEC requests plain English disclosure of commission loads and 12b-1 fees. What’s missing? Revenue sharing.
Revenue sharing is the devil that eludes even the most diligent of fund analysts. Its very existence is either hidden or, worse, not mentioned at all.
It is, as we all know, what drives platform fees that allow brokers to provide “free” custody of funds and recordkeepers to offer “low” or “no cost” services. It is the price every mutual fund must pay to play in the playground of retirement plans.
It is a price today’s true “clean” share mutual funds have refused to pay.
That’s why you don’t see them in retirement plans. That’s why you don’t see them on mutual fund platforms. That’s why you don’t see retirement professionals offering them (and, in fact, why they might not see them to begin with).
The worse thing for the broader mutual fund industry is for the concept of “clean” shares to go viral. This is ironic given it’s the biggest players in the mutual fund industry that have touted the possibility of “clean” shares.
Here’s what I predict: Very soon, some enterprising young kid will create a database of existing “clean” share mutual funds. This won’t be very popular among retirement plan specialists because these existing “clean” share mutual funds won’t be on any recordkeeping or custodian platforms.
At the same time, or shortly thereafter, we’ll begin to see a “clean” share rating be assigned to all mutual funds. That’s when “clean” shares will begin to become relevant to retirement plan platforms.
Class-action attorneys will begin to use these ratings the same way they used 12b-1 variations among different classes of the same fund to identify vulnerable class action targets. Litigation will become easier when the inevitable academic research, in confirmation of earlier research, starts to show a correlation between a high “clean” share rating and higher fund performance.
In the end, in all but isolated circumstances, mutual fund business models predicated on conflict-of-interest fees will no longer be sustainable. They will ultimately disappear, joining the likes of buggy whips, Walkmans, and VCRs in the museum of products from a bygone era.
And all this will occur with or without a fiduciary rule.