• Vitaly Novok

What Class of Shares Are You Offering?

Nothing could be worse for a plan sponsor than a lawsuit filed by its own employees. Just imagine, you set up a retirement plan, educate employees on various financial and investment topics, and even decide to participate in their retirement destiny by making contributions towards their retirement accounts. Then, boom, one day they file a lawsuit claiming that you didn’t care enough about their interests. In other words, they are accusing of breaching your fiduciary duty.


Unfortunately, many recent lawsuits filed against plan sponsors are valid. The decisions made against them prove that there are many violators out there. The two most common of these these legal cases are excessive fees that participants pay out of their accounts, and failure of plan sponsors to be proactive in terms of monitoring those fees and making the appropriate adjustments. There is no doubt that plan participants pay various fees, but we will leave that to a separate topic. What is more important is what you, as a plan sponsor, can do to make sure that the fees being paid by your employees are reasonable and minimize potential litigation.


Let’s look at investment fees charged by mutual fund companies, since they have one of the biggest impacts on employees’ retirement balances. All funds disclose in prospectuses and websites "the expense ratio". It is an annual fee that a shareholder must pay to a mutual fund company to cover its operating costs. Behind this single number is a plethora of other fees that the mutual fund company wants to put on the shoulders of its shareholders. For example, it could consist of 12b-1 fees, management fees, or administrative fees. In addition, there could be front-end or back-end load fees which investors must pay when they either buy or sell shares of a fund.


One way plan sponsors can minimize the negative effects of investment fees on employees’ balances is to make sure that they offer the right mutual fund classes to their participants.


Types of Mutual Fund Classes


Almost every mutual fund company will offer investors different types of shares or classes. All shares can be divided into two categories: retail (general public) and investor. No matter what type of shares you offer, your participants will be invested in the same strategy as other investors that own a different class of share of the same fund. So what is the catch? Each class of shares have different fees built into them.


Examples of retail classes of shares are A-shares, B-shares, and C-shares. Institutional classes of shares are primarily I-shares. However, they can also have different names or prefixes depending on the mutual fund company (Inst shares, R-shares, F-shares, etc).


Institutional shares, as the name suggests, are only available to institutional investors. The required minimum investment is usually $1,000,000+. Thus, those shares typically have lower fees.


Key differences between classes:



Are Institutional Shares Better?


As a plan sponsor, one of your most important duties is to minimize the expenses your participants incur and increase the probability a successful retirement. A simple way to do that is to make sure that the mutual funds in the investment menu offer the cheapest class of shares.


It is logical to assume that since I-shares usually have the lowest expense ratio, they should be offered. But it's not that simple. Institutional shares, unlike their retail counterparts, don't pay revenue sharing from mutual funds. This revenue can usually be used to pay reasonable plan expenses. Any remaining balance must be refunded to participants’ accounts.


For example, if a retail share class has an expense ratio of 0.7% but pays 0.3% in revenue sharing, the net expense ratio is 0.4%. If an institutional share class has an expense ratio below 0.4%, then it makes sense to use it. Otherwise, participants may be better off with retail share classes even though it may seem that they pay more in fees.


Another important point to mention is many plan sponsors forget that their fiduciary duty is to continuously monitor investments and remove imprudent ones. For example if there is a cheaper alternative available, you need to thoroughly check it and document whether it is prudent or not to use it. Just because it is cheaper doesn’t necessarily mean that it is better for the plan. However, be ready to provide a credible explanation and the reasoning behind your decision, just in case.

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