What Are 12b-1 Funds?
A 12b-1 fund is a mutual fund that charges its holders a specific type of fee known as a 12b-1 fee. This fee is allocated to cover distribution and marketing expenses and is usually paid as a commission to brokers who sell the fund. 12b-1 funds take a portion of the investment assets held to cover these expenses, which are included in the fund’s expense ratio and detailed in its prospectus. These fees are sometimes referred to as a “level load”.
Key Points to Know
- Covering Costs: A 12b-1 fund includes a 12b-1 fee that is charged to cover the fund’s sales and distribution costs.
- Fee Percentage: This fee is a percentage of the fund’s total market value, as opposed to funds charging a load or direct sales fee.
- Expense Breakdown: 12b-1 fees include the cost of marketing and selling fund shares, paying brokers and other sellers, and advertising costs such as printing and mailing fund prospectuses.
- Popularity Decline: The popularity of 12b-1 funds has declined in recent years due to the rise of exchange-traded funds (ETFs) and more low-cost mutual fund options.
Discovering the Mechanics of 12b-1 Funds
The term 12b-1 is driven from Rule 12b-1 of the Investment Company Act of 1940, which allows fund companies to act as distributors of their shares. This rule permits the use of a mutual fund’s assets to pay for distribution charges. These fees cover expenses like compensating brokers who sell the fund and paying advertising costs, including printing and distributing marketing materials. While the SEC does not currently set caps on the size of 12b-1 fees, FINRA regulations mandate that these fees, when used for marketing and distribution expenses, cannot exceed 0.75% of a fund’s average net assets annually.
Breaking Down 12b-1 Fees
Some 12b-1 plans also include shareholder service fees. These fees are paid to individuals or entities responsible for responding to investor inquiries and providing investment information. A fund can pay these fees without adopting a 12b-1 plan. If they are part of a 12b-1 plan, they will be listed in the fee table under that plan. Conversely, if paid outside the plan, they will appear in the “Other expenses” category. FINRA imposes a cap of 0.25% per year on shareholder service fees, irrespective of whether they’re part of a 12b-1 plan. Originally intended to bear advertising and marketing expenses, a very modest portion of this fee now goes towards these costs.
The Capped Percentage
0.75% is currently the highest amount of a fund’s net assets that investors can be charged under 12b-1 fees.
Important Considerations for Investors
Over the last several years, 12b-1 funds have plummeted in popularity. Due to an increase in exchange-traded fund (ETF) options and the proliferation of inexpensive mutual fund options, investors now have a variety of choices. Many experts view 12b-1 fees as a deadweight cost, and they advise investors to seek comparable funds that do not include such fees.
Related Terms: exchange-traded fund, FINRA, Investment Company Act, level load.
