Choosing the simplicity of NextShares
An alternative to the "Alphabet Soup-ization" of mutual fund share classes

Since their introduction earlier this year, NextShares have attracted widespread attention and acclaim in the fund industry. And no wonder: NextShares give actively managed funds the potential to achieve lower costs, better performance and lower capital gains distributions.

More than a dozen fund companies, along with distributors including UBS, Interactive Brokers, Envestnet and Folio, have announced their intent to offer NextShares because they’re seeking better investment outcomes for their clients.

But, NextShares may also provide something else: A simple solution to a vexing regulatory dilemma faced by broker-dealers and fund companies.

Are we running out of letters in the alphabet?

The Department of Labor (DOL) Fiduciary Rule requires financial advisors to act in the best interests of clients when managing their retirement accounts. It’s a worthy goal, but getting there may have some unintended consequences.


For example, when financial advisors — faced with a dizzying array of share classes and sales charge structures — choose a fund that provides more generous compensation, they may be accused of breaching their fiduciary duty. Broker-dealers quite rightly want to protect themselves, their advisors and their clients from this situation.

A number of broker-dealers have responded by asking fund sponsors to introduce a brand new mutual fund share class — unique to that firm — that level-sets compensation and marketing support (revenue-sharing) across fund providers. It’s a trend that appears to be picking up momentum.

That's a problem. Because if every major broker-dealer were to mandate a unique share class, the resulting alphabet soup of new share classes would expose investors, broker-dealers and fund sponsors to added costs and risks:

  • Higher fund expenses, which would be passed on to investors.
  • Higher costs for fund sponsors.
  • Potential for investor confusion.
  • Uncertainty about whether fund investments could be moved to another broker-dealer if the client or advisor were to switch firms.

There are already too many share classes and share-class snafus. It’s time to simplify.

Broker-dealers can choose to add to the share-class complexity — or they can simplify

What if there were a way to stop adding new letters to the alphabet soup and, instead, offer a single, universal share class — providing broker-dealers the flexibility to establish their own, unique sales charges? And to change those sales charges when market forces or client needs dictate, without establishing yet more share classes?


There is. It's called NextShares.

NextShares funds have no built-in sales charges. But broker-dealers are free to apply their own distinct sales charges (front-end, back-end or level-load), which can be identical for all NextShares funds they offer.

That’s different from a mutual fund, where broker-dealers effectively are required by Section 22(d) of the Investment Company Act of 1940 to impose sales charges in accordance with the fund’s prospectus. Therefore, to avoid a potential conflict under the DOL rule, broker-dealers need prospectuses for every fund to stipulate identical sales charges. Right now, a wide range of sales charges apply across funds available on broker-dealer platforms; hence, the need for a new share class to equalize them.

NextShares have exemptive relief from Section 22(d). This exemption allows the broker-dealer, not the fund company, to set NextShares sales charges.

And in advisory accounts, advisory fees payable on account assets invested in NextShares can be charged directly to clients like any position in today’s advisory relationships.


Moreover, with NextShares, broker-dealers could create a single, uniform standard for a marketing support (revenue-sharing) arrangement with fund companies, rather than relying on a series of complex, one-off agreements that differ for every company and every share class.

The bottom line: broker-dealers can attempt to mandate that fund sponsors create a new share class specific to their individual pricing needs — an initiative that is expensive, administratively complex, confusing and fundamentally reactive.

Or they can choose the simplicity of NextShares — an initiative that is innovative, simple, and has the potential to improve investor outcomes and industry growth.

Funds can avoid unnecessary costs

Implementing new share classes is expensive. Ongoing costs include state registration (blue sky) fees, legal, audit, accounting, transfer agency and administration costs that can total $25,000 per year — for each share class added.

If dozens of broker-dealers were to require new share classes, the costs could easily run into the tens of millions of dollars for some fund complexes — and hundreds of millions across the industry.


NextShares are a less expensive, easy-to-implement alternative. If broker-dealers adopt NextShares rather than mandating new mutual fund share classes, funds will avoid millions in additional share class expenses. And lower fund costs improve investor outcomes.

The regulatory process to offer NextShares is simple, straightforward and fast.

And, of course, there are added benefits: the potential for lower costs, better performance and tax efficiency compared to similarly managed mutual funds. Which are goals that everyone can agree on.

For more information on how to leverage NextShares to avoid share-class complexity, visit Contact Us. Working to provide better investor outcomes ... and simplify our industry.

 

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