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Difficulty: HardInvestment Companies and Managed Funds

A high-net-worth investor is evaluating mutual fund purchase options and comparing Class A, Class B, and Class C shares of an open-end growth fund. The investor plans to make an initial investment of $250,000 and maintain the position for a minimum of 10 years. Which of the following statements regarding the characteristics and suitability of these share classes are CORRECT?

  1. Class A shares are most suitable for this investor because the large initial investment qualifies for a sales load breakpoint discount, and Class A shares carry lower ongoing annual 12b-1 fees than Class C shares.Answer
  2. Class B shares assess a contingent deferred sales charge (CDSC) upon early redemption and generally convert into Class A shares after a specified holding period, eliminating the CDSC and lowering annual operating expenses.Answer
  3. C
    Class C shares are optimal for a 10-year holding horizon because they feature no front-end sales charge, resulting in the lowest cumulative expense ratio over extended investment periods.
  4. D
    Rights of accumulation allow the investor to apply breakpoints to Class C share purchases by combining account balances across unrelated fund families.

Answer

Class A shares are most suitable for large, long-term investments due to breakpoint discounts and lower annual 12b-1 fees, and Class B shares feature a contingent deferred sales charge (CDSC) that declines over time before converting to Class A shares.
The statements identifying Class A shares as suitable for large, long-term investments due to breakpoint discounts and lower ongoing 12b-1 fees, and describing Class B shares' CDSC structure and automatic conversion into Class A shares, are both correct. Class A shares provide sales load discounts at $250,000, and their lower annual expenses make them superior for a 10-year horizon. Class B shares convert to Class A shares after the CDSC period, lowering ongoing expenses.

Step-by-Step Solution

1
Analyze the investor's profile: investment amount ($250,000) and horizon (10 years).
The investor has a large capital commitment and a long-term time horizon.
Investment size determines breakpoint eligibility for front-end loads, and holding period determines the impact of ongoing annual 12b-1 fees versus front-end loads.
2
Evaluate Class A share characteristics.
Class A shares charge front-end loads eligible for breakpoint discounts at $250,000 and have low annual 12b-1 fees (capped at 0.25%). This is ideal for large, long-term investments.
Minimizing annual ongoing expenses maximizes compounding over a 10-year period.
3
Evaluate Class B share characteristics.
Class B shares feature a CDSC that drops to 0% after several years and then convert to Class A shares.
The conversion mechanism drops ongoing fees down to Class A levels for long-term holders.
4
Evaluate Class C share and Rights of Accumulation rules.
Class C shares have high ongoing 12b-1 fees (1.00%) that never convert, making them costly for long-term holders. Rights of accumulation apply to Class A front-end loads within the same fund complex.
Class C level loads continuously erode returns over long periods, and ROA cannot be aggregated across separate fund families.

Key Concept

Mutual Fund Share Classes (Class A, B, and C) and Fee Structures
Estimated Time:2m 0s
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Topics

Investment Companies and Managed Funds

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