Selected Topics in Mutual Fund Distribution

Abstract

This chapter working paper examines the channels through which mutual fund shares are distributed to investors: (1) direct, (2) advice, (3) retirement plan, (4) supermarket, and (5) institutional. The first four channels mainly serve individual investors. In the direct and institutional channels, fund distributors transact directly with investors in the sale and redemption of fund shares. In the other indirect channels, fund shareholders transact with funds through financial intermediaries. In 1980 the Securities and Exchange Commission adopted rule 12b-1, which emphasizes the role of independent fund directors in monitoring fund use of assets for distribution. The rule also addresses conflicts of interest between funds and fund advisers when funds pay distribution fees to grow fund assets. This chapter investigates whether introducing and adopting 12b-1 plans have benefitted shareholders and fund managers.This chapter provides an in-depth discussion of important issues related to mutual fund distribution. Two major topics are fund distribution channel characteristics and rule 12b-1 fees and distribution. Distribution channel characteristics discussed include direct channel, advice channel, retirement channel, institutional channel, supermarket channel, and multiple-share classes. Rule 12b-1 fees and distribution discuss adoption of rule 12b-1, rule 12b-1 after adoption, current 12b-1 fees, and issues with 12b-1 fees. A final major topic discussed direct sold and broker-sold services.The 12b-1 fee compensates brokers for initial sales of fund shares, ongoing servicing of fund shareholder accounts, and advertising and promotion expenses. Higher broker sales increase fund adviser assets under management (higher inflows) and adviser profits−primary motivations. Additionally, higher fund share sales increase broker profits, while higher broker fund share sales increase the size and cost of fund portfolio trades, amounts of broker commissions, and execution fees. Higher 12b-1 fees increase fund outflows, but higher share sales increase fund inflows. 12b-1 fees are transparent direct line-item costs in fund expense ratios that motivate using multiple share classes in direct and broker (and other intermediary) sold funds, including sales of fund shares to large individual and institutional investors. Payments reduce current fund net asset values (NAVs) and shareholder returns. Lastly, 12b-1 fees provide major agency conflicts with shareholder interests and returns.