Back-end loading

A back-end load is a fee paid by investors when they sell mutual fund shares, expressed as a percentage of the fund’s share value. A back-end load might be a fixed price or gradually reduced over time, often within five to 10 years. In the latter instance, the percentage is highest in the first year and decreases until it reaches zero. 

Key Characteristics of Back-End Loads:

1. Percentage of Sale Price: This is usually calculated as a percentage of the sale price or value of shares at the time of sale.
2. Decreasing over time: Normally, the longer you keep your investment with such loads attached, the slower they become. For instance, it may begin at 5% if shares are disposed of within the first year and reduce by 1% each year afterwards until nil after a specified period (generally 5-7 years).
3. Incentive for long-term investment: These fees encourage investors to hold onto their shares for longer durations, which could help improve overall fund performance through decreased turnover rates and trading expenses. 

Understanding Back End Load

Backend loads refer to fees charged when an investor redeems mutual fund shares. They may be known as exit fees or sales charges and are usually associated with different share classes of a fund. Class A shares typically carry a front-end load, while class B and class C shares are often subject to back-end loads. The type of share class selected by an individual will determine what they pay in sales load fees. 

Financial advisers can earn commissions by selling mutual funds that charge sales loads. To provide this opportunity for compensation, funds offer multiple classes of shares with varying structures. Besides, back-end loads should not be confused with redemption fees imposed by some mutual funds to discourage investors from trading them too frequently, thus disrupting their investment objectives. 

Calculation and Structure of the Back-End Load

Let’s have a detailed illustration of how the calculation is to be done: 

1. Initial payment: An investor buys US$50,000 worth of shares in a mutual fund. 
2. Fee structure: A 5% back-end load is slapped at first, which reduces by 1% annually. 1st year: 5% 2nd year: 4% 3rd year: 3% 4th year: 2% 5th year: 1% 6th year and beyond: 0% 
3. 1st year: 5% 
4. 2nd year: 4% 
5. 3rd year: 3% 
6. 4th year: 2% 
7. 5th year: 1% 
8. 6th year and beyond: 0% 
9. Value of shares at the time of sale: The shares will be sold after 2 years, when their worth will have grown to US$60,000. 
10. Fee Applicable: A 4% back-end load is imposed in the second year. 
11. Calculated Fee: US$60,000 x 4% = US$2,400 

If shares were redeemed after two years, the investor would pay US$2,400 as a back-end load. 

Structure

To incentivise investors to retain their assets for a longer period, back-end loads are structured in such a way that they decrease over time. The following are the main aspects of this arrangement: 

1. Types of shares: 

• Class A shares usually come with a front-end load (a fee charged upon purchase).  
• Class B shares typically have a declining back-end load. Class C shares might also carry a back-end load but generally have higher ongoing costs and reduce the charge over time. 
• Class C shares may also carry a back-end load but frequently entail higher continuous charges and a lesser reduction in the load over time. 

Fee Reduction Schedule: The fund’s prospectus stipulates a predetermined schedule for an annual decline in the back-end load.   

1. Deferred Nature: Instead of being paid when purchased at the front end, like front-end loads, these are deferred until the investor sells their shares. At the time of purchase, this delay makes it seem less expensive but still imposes a fee upon redemption.
2. Purpose: This design is meant to reward financial advisors and brokers during the investment’s life span as well as deter frequent trading activities that can drive up fund management expenses and disrupt investment strategies. 

Impact of Back End Load

Backend sales charges have a direct effect on an investor’s returns as well as their investment habits. Here is a brief summary of how they work: 

• Lower Net Returns: On selling their shares, investors face an immediate deduction from their proceeds. For example, selling US$60,000 worth of shares with a 4% back-end load results in a US$2,400 fee, reducing the net amount to US$57,600. This fee can diminish the overall returns, especially if the investment is sold early. 
• Long-Term Holding: The back-end loads are designed to decrease over time, which encourages investors to hold onto their shares for an extended period. This means that if a charge starts at 5% and goes down by 1% every year, then after a few years of keeping the investment, the cost will be significantly reduced, thereby suiting long-term investment objectives. 
• Behavioural Implications: Forcing people out early attracts heavy penalties through back-end charges, thus hindering short-term trading. When this is done, it becomes expensive because frequent buying and selling comes with high costs and may interfere with the performance of the fund. 
• Impact on Fund Stability and Performance: Funds that have a back-end load can undergo reduced turnover, which will lower transactional expenses, leading to stability in fund management over a long period of time and enabling the realisation of better performance. 

Examples of Back End Load

Short-Term Holding 

• Amount Invested Initially: US$50,000 
• Charges: 5% for the first year, with a subsequent reduction of 1% each year thereafter. 

 Sale after 1 Year

• Value of Shares when Sold: US$55,000 
• Charges: 5% of US$55,000 = US$2,750 
• Net Proceeds: US$52,250 

Medium-Term Holding 

• Initial Investment: US$50,000 
• Fee Schedule: 5% in the first year, decreasing by 1% each subsequent year. 
• Scenario: Selling After 3 Years 
• Value of shares when sold: US$65,000 
• Charges: 3% of US$65,000 = US$1,950 
• Net proceeds: US$63,050 

Frequently Asked Questions