Mutual Fund Selection: Share Classes

XPYRIA Team Insights

Mutual Fund Selection: Share Classes

Bradley Prosper, CFA®, CFP® XPYRIA Team Insights

Key takeaway: XPYRIA analyzes client accounts on an ongoing basis to ensure that each investment has the lowest net cost.

Mutual funds often have more than one share class. At XPYRIA, we invest in the “Institutional” share class or the lowest cost option. Every quarter, we analyze if we own the cheapest share class across all client accounts. There are a few rare exceptions that lead us to choose a share class that is not the institutional class, but this is typically because the chosen share class has no trading costs. For example, if we assume we trade four times per year, many institutional share classes at Schwab would cost $60 to trade for the year ($15 per trade). If the difference in expense ratios amounts to less than $60, we would be benefitting a client by actually owning the share class with a higher expense ratio and no trading costs.

Let’s take a look at a real example on Schwab’s platform. Oakmark is a large cap fund with multiple share classes, and for the sake of this analysis let’s look at two of those share classes. OAKMX (Investor Class) has a net expense ratio of 0.91% and no trading costs – it’s free to trade. OANMX (Institutional Class) has a net expense ratio of 0.68% and costs $15 each time we trade it. OAKMX and OANMX own the same stocks, the only difference between them is the expense ratio and trading cost on the Schwab platform. If a client has $20,000 invested in Oakmark Fund, which share class should be used? We look at the difference in expense ratios and multiply that by the dollar value invested in the Fund to see if it’s more or less than $60. In this scenario, we multiply 0.23% (0.91% - 0.68%) by $20,000 to get a result of $46. The client would be expected to benefit from owning the Investor Class – OAKMX – as the $46 difference in expense ratios is less than the expected annual trading costs of $60 for the Institutional Class (OANMX). In other words, we would be benefitting this client by approximately $14 per year by owning OAKMX instead of OANMX. In this scenario with a 0.23% expense ratio difference, a client would need to have $26,087 in Oakmark Fund in order for the Institutional share class to be the better fit.

Once we analyze the share classes, we execute any exchanges that need to be made in order to benefit the client. Schwab, for example, does share class exchanges on the first three Wednesdays of every month (except December). Converting from one share class to another on these exchange dates is a non-taxable event. Typically only a handful of exchanges are executed each quarter, and it’s usually positions that were on the cusp of the $60 threshold the last time we analyzed the share class. We also analyze new positions that come over from outside accounts on an ongoing basis and will seek to either 1) liquidate the position or 2) keep the position and ensure it’s in the lowest cost share class.

There are additional complexities involved in the share class exchange process besides the $60 threshold such as:  which custodian is used, is the client in decumulation phase and taking withdrawals, is the account on the asset-based-pricing master, are there any anticipated one-off expenditures, etc. We wanted to provide you a behind-the-scenes look at this process, but we also have to keep in mind that there is no “one size fits all” and that each client’s situation is analyzed on an individual basis to determine the best fit for his/her/their needs.

About the Author

Bradley Prosper, CFA®, CFP®

Senior Research Analyst
Mr. Prosper is a member of the Firm’s investment research group where he assists in conducting investment research that is instrumental in the construction, maintenance, and management of client portfolios. This research includes the procurement of primary data via direct investment manager interviews as well as analyzing information from our data resources.