EXCLUSIVE: Morgan Stanley to Squeeze Mutual Fund Sales Compensation
Morgan Stanley will convert all “Class C” mutual fund shares held by customers for six or more years to load-waived “A” shares that pay brokers lower annual fees, according to sources familiar with a memo being sent to its almost 16,000 financial advisors this afternoon.
The change will affect brokers who sell funds in commission-based transaction accounts, rather than in the fee-based advisory accounts that Morgan Stanley and other companies prefer because those accounts produce ongoing annual income and help firms avoid charges of favoring investments with higher commissions.
The volume of higher-expense C shares that are sold industrywide has been declining due to heightened investor sensitivity to fund expense ratios and firm sensitivity to regulatory oversight, but a significant number of brokers sell them.
They argue that the C shares, which generally pay brokers 1% of the value of their customers’ fund share holdings annually rather than the .25% trail on A shares, benefit long-term investors will pay less in a commission than in an advisory account. And some customers simply who dislike paying upfront “load” on new A-share purchases.
Several Morgan Stanley brokers told AdvisorHub that they plan to “flip” C shares, selling out of one fund into another’s similar share class as they approach conversion date so that they can continue collecting the higher so-called 12b-1 fee, or trail.
“Losing 75 basis points on every six-year-old share on my team’s book will cost us $300,000 in gross and $120,000 in commissions,” lamented one broker, who said the team expects to “flip til the cows go home.”
Officials at brokerage firms counter that they have strong surveillance systems that can catch such flipping patterns. C shares continue to be appropriate for investors with short-term investment horizons because there is no upfront charge, they say, but that effect is dissipated by long-term annual payments to brokers.
Merrill Lynch several years ago adopted a policy that converts customers C shares to A shares on all of its thousands of funds after 10 years unless a particular fund company has a more advantageous conversion requirement. Few fund companies have such conversion requirements, although American Funds and Ivy Funds have a ten-year requirement.
The changes come as brokerage firms have become more sensitive to compensation issues in the buildup to the DOL fiduciary rule that affected customer-care standards in tax-friendly retirement accounts and as the Securities and Exchange Commission prepares a fiduciary standard for taxable accounts.
C shares also are generally more popular with smaller investors, a population that many firms have been guiding advisors away from. Morgan Stanley generally does not pay brokers on household accounts below $100,000 and Merrill Lynch excludes accounts under $250,000 from brokers’ compensation grids.
Despite their status as a revenue staple for many brokers, C-share sales have been waning. Total assets held in the share-class as of last month had fallen 15% to $581.2 billion from $105.6 billion ten years earlier, according to Broadridge Inc.
|“C” SHARE FUND ASSETS ARE FALLING|
|(Across equity, alternatives, bond, commodity, mixed and money-market funds, $ in millions)|
|1-Year (as of Feb. 2018)||3-Year||5-Year||10-Year (Feb. 2008)|
|Total “C” Assets||$581,245||$686,836|
Source: Broadridge Inc
A net $105.2 billion left mutual fund C shares in the past 12 months, and $233 billion has fled the high-trail share class over the past three years across all fund asset classes as of the beginning of February, notwithstanding robust stock and bond markets in the periods, according to Broadridge.
“There are business pressures to get rid of smaller accounts, as well as regulatory and legal pressures to avoid accounts whose portfolios create a conflict of interest,” Paul Ellenbogen, a vice president at Broadridge Financial Solutions’ U.S. Regulatory and Compliance unit, wrote in an email. “But every $100 billion outflow from C shares means at least $750 million in foregone 12b-1 fee revenue, which would have to be replaced by explicit fees for service and/or advice.”
Morgan Stanley’s memo to its brokers on Tuesday also will indicate that the firm will continue to eliminate certain mutual funds from its platform that have not performed well or that have not attracted many assets. Last year the company began the winnowing process, and excluded Vanguard Funds from its platform because the company will not pay brokerage firms for so-called shelf space.
Morgan Stanley also is adding incentives to encourage its brokers to collect more cash from their investment customers, another growing trend among big firms that have commercial banking affiliates.
Effective Thursday, Morgan Stanley is raising the interest rate it will pay depositors, with the increase higher for larger deposits. As of August 1, the firm also will reinstate a revenue credit to brokers of 5 basis points of the average balance in a client’s deposit account. The credit will be applied only to deposits and other short-term liquidity products held in non-advisory accounts to avoid a double payment to brokers, the sources said.
The company also will eliminate the option of allowing new customers to have cash in their investment accounts swept into money-market accounts as of April 9, a move that several bank-affiliated competitors have also instituted since banks make wider spreads on bank deposits. The conversion from money-market to bank deposit account for existing clients will occur on August 13.
To placate investors upset over what is likely to be marginally lower returns on their cash, Morgan Stanley will guarantee a preferred interest rate in the bank deposit program that will exceed what they were receiving in the money fund for at least six months.
In another signal of its sensitivity to pricing, Morgan Stanley is lowering the maximum fee it will charge clients in its Consulting Group managed account programs to 2.0% from around 2.5% as of October 1, 2018, said people familiar with contents of the memo that is being sent to the firm’s “field” by its regional directors.