NAV, POP, loads and breakpoints

The gap between what it is worth and what you pay

Net asset value is what a share of the fund is worth: total assets minus liabilities, divided by the shares outstanding, computed once each trading day. The public offering price is what a buyer hands over. In a no-load fund the two are the same. In a front-end load fund the public offering price is higher, and the difference is the sales charge that pays the distributor and the selling firm.

The sales charge is quoted as a percentage of the public offering price, not of the amount invested, which is why the arithmetic confuses people. To get from value to price you divide rather than multiply: the public offering price equals net asset value divided by one minus the load. Multiplying the net asset value by one plus the load instead gives a number that is close enough to look right and is always wrong.

Breakpoints are the volume discount. A fund publishes a schedule reducing the sales charge once an investment reaches stated levels. Steering a customer to stop just below a breakpoint, so the firm keeps the larger charge, is a sales practice violation with a name of its own, and the rule names it too: no member may sell fund shares in dollar amounts just below the point at which the sales charge is reduced, so as to share in the higher charge.

Two devices reach a breakpoint without one large check. A letter of intent is a forward-looking promise to invest the qualifying amount within a set period, usually 13 months; the lower charge applies from the start. If the investor falls short, the fund may deduct the higher charge that fits what was actually invested. Some funds also let a letter count purchases made shortly before it was signed; the fund’s own terms set how far back. Rights of accumulation look backwards instead, giving credit for what the investor already holds in the fund family. One is a promise, the other is a balance.

The expense ratio is the other half of what a fund costs, and it is different from a load. It is the percentage of the fund’s average net assets used each year to pay operating expenses — management fees, the distribution and service fees known as 12b-1 fees, acquired fund fees and expenses, and other expenses — and it appears in the fee table at the front of the prospectus. A load is charged once, on the way in or the way out, and comes off the money invested. An expense ratio is charged every year for as long as the investment is held, quietly, out of assets. Over a long holding period the smaller-looking annual number is usually the larger cost, which is why a question comparing two share classes is rarely answered by the load alone.

Exam terms

Net asset value

The per-share value of the portfolio; what a redeeming investor receives.

Public offering price

What a buyer pays: net asset value plus any front-end sales charge.

Sales charge (load)

The distribution cost, quoted as a percentage of the public offering price.

Breakpoint

An investment level at which the fund’s schedule reduces the sales charge.

Letter of intent

A promise to invest to a breakpoint within a period, usually 13 months, earning the lower charge now.

Rights of accumulation

Credit for holdings already owned in the fund family when pricing a new purchase.

One portfolio, several tollbooths

The same fund is often sold in more than one class. It is worth being exact about what that does and does not change. Every class of a fund holds identical investments and has the same investment objectives and policies. What differs is the fees and expenses, and because the fees differ the classes report different performance from the same portfolio. Nothing about the securities the manager buys changes between them.

A multi-class structure exists so an investor can choose the charging arrangement that suits their situation, and the SEC frames the choice around one variable in particular: the time they expect to remain invested. That is the thread to pull on in any question that gives you a holding period.

Two charging shapes do most of the work. A front-end sales load is an upfront fee paid on purchase; it is deducted from the money handed over, so less of it buys shares, and it typically compensates the broker who sold the fund. A contingent deferred sales charge is the common back-end load: it is paid when the shares are sold back to the fund, its size depends on how long they were held, and it may fall gradually to zero if they are held long enough. Pay on the way in, or pay on the way out and less the longer you wait.

The letters are the conventional labels rather than a rule any regulator states: Class A is used for the front-end load, Class B for the contingent deferred sales charge (B shares are no longer widely available), and Class C for a level ongoing charge, often with a deferred charge for an early period, often a year. Learn them as vocabulary the examination uses, and reason from the charging shape rather than from the letter, because the charging shape is what a question actually depends on.

Exam terms

Share class

One of several fee structures offered on the same portfolio.

Front-end sales load

Charged on purchase and deducted from it, so less money buys shares.

Contingent deferred sales charge (CDSC)

Charged on redemption; falls the longer the shares are held, often to nothing.

Level load

An ongoing annual charge instead of a large charge at either end.

Worked example

A fund is quoted at a net asset value of $9.40 with a 6 percent front-end sales charge, and an investor has $9,400 to put in.

1. Start with the formula. The public offering price is the net asset value divided by one minus the load: $9.40 ÷ (1 − 0.06) = $9.40 ÷ 0.94 = $10.00.
2. Check the charge from the other direction. The gap between $10.00 and $9.40 is $0.60, and $0.60 ÷ $10.00 is exactly 6 percent of the public offering price, which is how the charge is quoted.
3. See what the wrong method gives. Multiplying $9.40 by 1.06 produces $9.964, which looks plausible and is wrong, because it charges 6 percent of the wrong base.
4. Apply the price. $9,400 buys $9,400 ÷ $10.00 = 940 shares, and those shares are worth 940 × $9.40 = $8,836 the moment they are bought.
5. The $564 difference is the sales charge the investor has paid, which is why a front-end load fund starts below water and needs performance to recover the charge.

Check yourself

Try a question, then read the explanation to review the rule.

Same rule, new context

Related practice

• NAV, POP and sales chargePractice this
• Share classes and the charging structurePractice this