Frequently the investor must pay a sales charge for purchasing shares in a mutual fund. The sales charges, or loads, may be applied either when the investor buys the shares or when they are sold. Front-end loads are applied to the initial purchases of fund shares. Back-end loads are applied when they are sold. A fund may be offered with multiple share classes, each of which has a different sales charge and expense distribu- tion structure. Investors are interested in calculating returns reflecting these sales costs.
Front-End Load-Adjusted Returns
Some funds have front-end loads, which are sales charges levied upon the initial purchase of shares in a fund. A portion of the investor’s initial contribution is paid as a load reducing the initial contribution and the remainder is used to purchase shares in the fund. The load amount usu- ally depends on the size of the initial contribution, and it usually declines as the size of the initial investment increases. The price that the investor pays for the shares is adjusted from the NAV to an offer price by the percentage amount of the sales charge. To calculate the return that reflects the smaller initial investment, we
1. Calculate the offer price using the begin NAV and sales charge.
2. Calculate begin of period shares using the offer price and assumed investment of $1000.
3. Calculate reinvestment shares for each distribution.
4. Calculate the growth rate and transform into a return.
For example, if we took the same NAV and dividend information from the previous example, and assumed that there was a 5.75% initial sales charge, we would calculate the return by:
Adjusting Returns for Impact of Fees, Taxes, and Currency 83
EXHIBIT 6.9 Front-End Load Fund Returns
First, calculating the offer price using the begin NAV and sales charge:
(6.8)
In terms of our example:
Starting with the same $1000 initial investment, the front-end load has the effect of reducing the shares purchased. The lower base is used to calculate the reinvestment shares on subsequent dividend distribu- tions, as in Exhibit 6.9.
The cumulative return in this case is 30.67%, versus 38.64% in the no load example with the same NAV and distribution history. Not only does the load immediately impact the return, having the effect of putting the investment underwater from the start, but the difference compounds as dividends are received and reinvested in subsequent periods.
Back-End and Deferred Loads
Funds that levy the sales charge when the investor redeems their shares are deferred-load, or back-end load, funds. The investor pays no sales charge on purchase and all of the initial contribution goes to purchase fund shares. Most back-end loads are structured as contingent deferred sales charges(CDSC). CDSC is a back-end load that declines over time.
For example, if you sell mutual fund shares after one year, the sales charge may be 4% and after three years the charge may decline to 2%
and then to 0% after five years. The process of calculating the return on a portfolio with a deferred load is to:
Offer price NAV per share 1 Front-end load–
( )
---
=
84 RETURN MEASUREMENT
1. Calculate beginning of period shares using an assumed investment of
$1000.
2. Calculate reinvestment shares for each distribution.
3. Calculate the ending market value prior to the levy of the sales charge.
4. Adjust the ending market value by subtracting the sales charge.
5. Calculate growth rate and transform into a return.
Continuing with the same NAV and distribution history as in the prior examples, suppose the fund has a back-end sales charge of 5% on shares held one year or less.
The first step is to calculate the beginning of period shares. As with the no load example, this is equal to the assumed investment of $1000 divided by the NAV at the end of the day the contribution is made. Any dividends received are assumed to be reinvested and reinvest shares are calculated and accumulated to the end of the period.
For calculating returns on a fund with a CDSC charge, we assume that the shares are going to be sold at the end of the calculation period.
The ending market value is the ending NAV per share times the end shares. We then adjust the ending market value by the amount of the load and use the resulting number in the return calculation.
To calculate the adjusted ending market value:
1. Find the lower of the NAV at the end of the period or the NAV at the beginning of the period:
(6.9) 2. Calculate the back end fee:
(6.10) 3. Calculate an Adjusted Ending Market Value:
(6.11) 4. Calculate the return by dividing the adjusted EMV by the assumed ini-
tial investment:
(6.12) CDSC NAV = Lower of Begin NAV End NAV( , )
CDSC sales charge
Beginning shares×(CDSC NAV×Load %)
[ ]
=
Adjusted ending market value End shares×Ending NAV
( )–CDSC sales charge
=
Periodic return Adjusted EMV 1,000 ---
1 – ×100
=
Adjusting Returns for Impact of Fees, Taxes, and Currency 85
EXHIBIT 6.10 Back-End Load-Adjusted Return
Exhibit 6.10 illustrates the calculation of a return for a fund with a back-end load. The back-end load-adjusted return is 33.64%. Notice that the back-end sales charge is not levied on shares received via the process of reinvesting dividends. In addition, the use of the lower of the begin or the end NAV results in a lesser sales charge on a loss experienced by the investor if the NAV falls instead of rises over the measurement period.