Question

The Investments Fund sells Class A shares with a front-end load of 6% and Class B shares with 12b-1 fees of .5% annually as well as back-end load fees that start at 5% and fall by 1% for each full year the investor holds the portfolio (until the fifth year). Assume the portfolio rate of return net of operating expenses is 10% annually. If you plan to sell the fund after 4 years, are Class A or Class B shares the better choice for you? What if you plan to sell after 15 years?

Answer 1

Following information is given in the question:

Class A shares Front end load = 6%

Class B shares with 12b-1 end load per annum= .5%

Back load fees = starting at 5% and fall by 1% (till the 5th year)

Portfolio rate of return (net of operating expenses) = 10%  per annum

a. Return on selling the fund after 4 years

Assume the initial investment value is $500

Class A return = Value of the initial investment net of front end load charges at the end of year 4 = (($500-($500*6%))*(1+10%)^4 = $688.13

Class B return = Value of the initial investment net of 12b-1 charges at the end of year 4 and also net of back load fees of 1% = ($500*(1+(10%-.5%)^4)*(100%-1%) = $711.64

(12b-1 is a annual marketing fee on a mutual fund. These are like fund's operational expenses and hence reduced from the portfolio rate of return )

Since the return is higher in Class B ($711.64 > $688.12), better choice is Class B for selling after 4 years.

b. Return on selling the fund after 15 years

Assume the initial investment value is $500

Class A return = Value of the initial investment net of front end load charges at the end of year 15 = (($500-($500*6%))*(1+10%)^15 = $1,963.31

Class B return = Value of the initial investment net of 12b-1 charges at the end of year 15. There is no back-end loan for sale after 15 years since it is beyond the 5 years = ($500*(1+(10%-.5%)^15) = $1950.67

Since the return is higher in Class A ($1,963.31 > $1,950.67), better choice is Class A for selling after 15 years. This is because the impact of 0.5% of 12b-1 charges which gets accumulated over 15 years reduces the return for Class B.