Investors in deferred load mutual funds pay sales commissions when they sell fund shares rather than when they buy shares. In some cases, the deferred load declines as the holding period increases. As a result, the fund effectively becomes a no-load fund if the investor holds his shares a requisite number of years.
A mutual fund imposes the deferred load -- a back-end sales charge -- when the investor redeems his shares. As a result, the entire amount an individual originally invests in the fund is used to purchase fund shares. When the shares are redeemed, the deferred load might be calculated on the lesser of the value of the shareholder's original investment or the net-asset-value of his investment at redemption. For example, assume an individual invests $30,000 in a mutual fund with a 5-percent deferred load. Over one year, the investment appreciates to $32,000. In this case, the deferred load is equal to $30,000 -- the lesser of $30,000 or $32,000 -- multiplied by 5 percent equals $1,500. The fund deducts the $1,500 sales charge from the shares’ redemption value when the investor sells the fund shares.
Contingent Deferred Sales Load
The size of a contingent deferred sales load that an investor must pay when shares are redeemed declines over the shares holding period. In fact, the CDSL typically decreases to zero if the shares are held a sufficiently long period of time. For example, a 5-percent CDSL might be charged at redemption for fund shares held for one year, and 4 percent if shares are held two years and so on until the CDSL is zero. The particulars of a CDSL are disclosed in the deferred-load fund prospectus.
Purpose of CDSL
Due to the opportunity to decrease the amount of a back-end load he must pay when shares are redeemed, an investor might hold their fund shares for a longer time. In turn, the amount of cash a fund must keep on hand to pay out unexpected redemption is less, which allows fund management to invest in less liquid securities that might perform better than more liquid securities. However, M. R. Morey writes in “Deferred-load Mutual Funds: Duds or Divine,” that average deferred load funds do not outperform the average no-load funds. In fact, Morey states the opposite is true.
Deferred Loads Research
You can read the fund prospectus to determine the method used to calculate the deferred load. For example, the deferred load might be calculated either on your initial investment or your entire interest in the fund net other fees and expenses. Also consider how long you must hold your shares until any CDSL charges decrease to zero. Of equal importance is that a fund with a CDSL will often impose an annual 12(b)-1 fee as well. Therefore, when you compare dollars you might receive from various investments, be sure to deduct all fees and expenses and compare possible net -- not gross -- returns.
- Mutual Funds: Portfolio Structures, Analysis, Management, and Stewardship; John A. Haslem
- Investment Performance Measurement; Bruce J. Feibel
Billie Nordmeyer works as a consultant advising small businesses and Fortune 500 companies on performance improvement initiatives, as well as SAP software selection and implementation. During her career, she has published business and technology-based articles and texts. Nordmeyer holds a Bachelor of Science in accounting, a Master of Arts in international management and a Master of Business Administration in finance.