Unmasking F-Class Funds

F-Class mutual funds are gaining in popularity as investors begin to understand the benefits.  Designated in 1999, they are available for fee-based clients only, and the majority of fund companies offer them.

To understand F-Class we need to understand the types of fees associated with mutual funds.  All mutual funds have annual fees and service fees.  Combined they are often referred to as the Management Expense Ratio (MER).  The annual fees include the fees to the portfolio manager and the ongoing expenses of the fund.  The service fee is the amount that is paid to the investment firm that is holding the investment, a portion of which is generally paid to the advisor.

Let’s use a fictional mutual fund called XYZ Fund.  The XYZ Fund has an annual MER of three per cent that is comprised of an investment management fee of one and a half per cent, administrative and operating expenses of a half of a per cent and a service fee (often referred to as trailer fees) of one per cent.  With regular mutual funds, the three per cent is deducted from the adjusted cost base of the fund and the mutual fund company sends the servicing firm one per cent.  With F-Class mutual funds, only two per cent would be deducted within the fund and the fund company does not compensate the servicing firm.

How is F-Class different?

The structure of the MER is different with F-Class mutual funds than with regular mutual funds.  Fee-based clients are already paying a fee to their advisor based on the assets in their account (including mutual funds) so the fund companies have eliminated the advisor commission component, thereby eliminating a duplication of fees for the client.  The F-Class version simply excludes the one per cent service fee, making the XYZ Fund available with an MER of two per cent (rather than three per cent).

Why is this important?

Five reasons why we like F-Class:  1) Fee Transparency, 2) Fee Flexibility, 3) Commission, 4) Tax Efficiency, and 5) Benefits for RRSPs and RRIFs

1.  Fee Transparency:  With regular mutual funds the fees are embedded in the unit price and are not transparent unless one is inclined to read through the prospectus and financial reports.  The unit value of the fund declines when the fees are charged.  With F-Class funds the investment management fees and administrative and operating expenses totaling two per cent are still embedded in the unit price.  The service fee is charged by the investment firm directly allowing the individual investor to clearly see the fees paid.

2.  Fee Flexibility:  With regular class mutual funds the ongoing fees paid to the investment firm are set by the mutual fund company, there is no flexibility.  With fee-based accounts, the client and advisor agree on an appropriate fee to be charged.

3.  Commission:  The majority of mutual funds have been purchased on either a front-end (initial service charge) or back-end (deferred sales charge) basis.  Front-end means that the investor paid a commission to the investment firm when the fund was first purchased.  With back-end purchases, the fund company paid the investment firm the commission at the beginning and the investor paid no commission.  If the investor sells the position, the fund company will charge the investor a redemption fee that declines with time; however, this is generally zero if the fund was held for seven years or more.  F-Class is considered no-load as it has no commissions to purchase or sell, resulting in greater flexibility.

4.  Tax Efficiency:  For non-registered accounts the quarterly fees charged for F-Class are fully deductible on schedule four of your tax return when paid, even though you may still hold the underlying security.  With regular mutual funds the fees are deducted automatically and have the effect of lowering the current market value of the fund.  When you ultimately sell the regular mutual fund then the difference between the adjusted cost base and the current market value is a capital gain (loss).  As only one half of capital gains are taxable, investors are essentially only getting a deduction for half of the embedded fees.

5.  Benefits for RRSPs and RRIFs:  Although investors are not able to deduct the fees associated with F-Class mutual funds held within a registered accounts they are able to pay the fees by contributing outside money.  Contributions into the account to pay fees are not deductible; however, this does allow the investments within the account to compound even more.

F-class is one of the benefits available to investors that have a fee-based account.  You may want to talk to your advisor to see if a fee-based account is right for you.