What Is Contingent Deferred Sales Loads?
A contingent deferred sales load (CDSL), often referred to as a "back-end load" or contingent deferred sales charge (CDSC), is a fee imposed on investors when they sell or redeem shares of a mutual fund within a certain period after purchase. This type of fee falls under the broader category of investment fees and is a common feature of certain share classes of mutual funds. Unlike a front-end load, which is paid at the time of purchase, a contingent deferred sales load is incurred at the time of redemption. The specific percentage charged typically declines over time, often reaching zero after a predetermined holding period, such as five or six years. Funds that charge a contingent deferred sales load usually also levy annual 12b-1 fees to cover distribution and marketing expenses.11
History and Origin
Sales loads, including contingent deferred sales loads, emerged as a way for mutual fund companies to compensate broker-dealers and financial advisors for selling fund shares. While front-end loads were historically more prevalent, the introduction of CDSLs offered investors the ability to invest their full capital upfront, with the sales charge only applied if they sold their shares before a specified period. This structure was designed to incentivize longer-term investing by making early withdrawals more costly. The Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) regulate mutual fund sales charges, including contingent deferred sales loads, to ensure they are fair and transparent to investors. FINRA Rule 2830, for example, defines "sales charges" to include deferred and asset-based sales charges and sets limits on their maximum percentages.9, 10
Key Takeaways
- A contingent deferred sales load (CDSL) is a fee paid when selling mutual fund shares, typically decreasing over time.
- It encourages investors to hold shares for a specified period, often several years, to avoid or minimize the fee.
- CDSLs are typically associated with Class B and Class C mutual fund shares, which may not have an upfront sales charge.
- Funds with CDSLs often charge higher ongoing annual expense ratios, including 12b-1 fees.
- The fee is calculated as a percentage of the lesser of the original purchase price or the redemption value.
Formula and Calculation
The calculation of a contingent deferred sales load is typically based on a declining percentage that depends on the length of time the shares have been held. It is often applied to the lesser of the original purchase price or the current net asset value (NAV) at the time of redemption. This method ensures that investors are not penalized with a higher sales load if the fund's value has increased significantly.
The formula for calculating the contingent deferred sales load:
The "Applicable CDSL Rate" decreases annually. For example, a common CDSL schedule might be:
- Year 1: 5%
- Year 2: 4%
- Year 3: 3%
- Year 4: 2%
- Year 5: 1%
- Year 6 and beyond: 0%
Interpreting the Contingent Deferred Sales Loads
Understanding a contingent deferred sales load is crucial for evaluating the true cost of a mutual fund investment. While the absence of an upfront sales charge might seem appealing, the presence of a CDSL means that liquidity comes with a potential cost. Investors need to consider their anticipated holding period. If an investor expects to sell shares within the initial years, the contingent deferred sales load can significantly erode returns. Conversely, for long-term investors who intend to hold the fund beyond the CDSL period, this fee may eventually disappear, making the fund functionally "no-load" at that point. A financial advisor can help assess whether a fund with a CDSL aligns with an investor's time horizon and investment goals.
Hypothetical Example
Consider an investor, Sarah, who puts $10,000 into a mutual fund with a contingent deferred sales load schedule as follows: 5% in year 1, 4% in year 2, 3% in year 3, 2% in year 4, 1% in year 5, and 0% thereafter.
Scenario 1: Sarah redeems after 2 years.
Sarah’s initial investment portfolio was $10,000. After two years, let's say her investment has grown to $11,000.
The CDSL rate for year 2 is 4%.
The CDSL is calculated on the lesser of the initial investment ($10,000) or the redemption value ($11,000), which is $10,000.
CDSL Amount = $10,000 * 0.04 = $400.
Sarah receives $11,000 - $400 = $10,600.
Scenario 2: Sarah redeems after 6 years.
Sarah holds her shares for six years. By this time, the contingent deferred sales load has stepped down to 0%.
Regardless of the fund's value at redemption, no CDSL is applied. Sarah, as a shareholder, would receive the full redemption value of her shares.
Practical Applications
Contingent deferred sales loads are primarily found in mutual fund Class B and Class C shares, designed to appeal to investors who prefer to avoid an upfront sales charge. These fees often provide compensation to the broker-dealer who sold the fund's securities. For individual investors, the primary application of understanding CDSLs lies in selecting the most cost-effective share class for their investment horizon. Investors intending to hold a mutual fund for many years might find that a fund with a CDSL ultimately costs less than one with a high front-end load, especially if the fund's ongoing expenses are competitive. However, for investors with shorter-term goals or those who anticipate needing to access their capital sooner, a CDSL can become a significant drag on returns. R7, 8ecent trends indicate a strong investor preference for lower-cost options and no-load funds, leading to a significant decline in average expense ratios across the industry.
6## Limitations and Criticisms
While contingent deferred sales loads offer the benefit of immediate full investment, they face several criticisms. One major drawback is the disincentive they create for investors to switch funds, even if a better investment opportunity arises or their personal financial situation changes. This "lock-in" effect can limit an investor's flexibility in managing their diversification strategy. Additionally, funds with contingent deferred sales loads often carry higher ongoing annual expenses, particularly 12b-1 fees, compared to Class A shares or no-load funds. Over long periods, these higher annual fees can amount to more than a front-end load, significantly impacting overall returns. Critics also argue that the complex fee structures, including CDSLs, can be confusing for retail investors, making it difficult to compare the true costs of different mutual fund offerings. T4, 5he declining trend in fund fees across the industry, as reported by sources like Morningstar, suggests a shift towards more transparent and lower-cost investment vehicles.
2, 3## Contingent Deferred Sales Loads vs. Front-End Load
The primary distinction between a contingent deferred sales load (CDSL) and a front-end load lies in when the sales charge is incurred. A front-end load is deducted from the investor's initial investment amount at the time of purchase, meaning a smaller portion of the capital is immediately invested in the fund. For example, if an investor puts in $10,000 with a 5% front-end load, only $9,500 is actually invested. In contrast, a contingent deferred sales load is assessed when shares are redeemed or sold. The full $10,000 would be invested upfront, but a fee would be charged upon exiting the fund if the holding period requirements are not met. While a front-end load reduces the initial investment amount, a CDSL can reduce the proceeds received upon liquidation. Each structure caters to different investor needs and time horizons, with the choice often depending on whether an investor prioritizes maximum upfront investment or flexibility in exiting the fund without immediate charges.
FAQs
What is the main purpose of a contingent deferred sales load?
The main purpose of a contingent deferred sales load is to compensate the selling broker-dealer or investment adviser for distributing the mutual fund shares, while allowing the investor's entire initial investment to be put to work immediately. It also encourages investors to hold their shares for a longer period to avoid or minimize the fee.
How does a CDSL decline over time?
A contingent deferred sales load typically declines by a fixed percentage point each year and eventually reaches zero after a specific number of years, often ranging from five to seven years. This declining schedule is outlined in the mutual fund's prospectus.
Are all mutual funds subject to a contingent deferred sales load?
No, not all mutual funds or mutual fund share classes have a contingent deferred sales load. Many mutual funds are "no-load" funds, meaning they do not charge any sales loads (front-end or back-end). Additionally, Class A shares typically charge a front-end load, while Class B and Class C shares are more commonly associated with CDSLs.
Can I avoid paying a contingent deferred sales load?
Yes, you can avoid paying a contingent deferred sales load by holding your mutual fund shares for the entire period specified in the fund's prospectus, after which the fee reduces to zero. You might also avoid it if you exchange shares within the same fund family, depending on the fund's rules.
Is a contingent deferred sales load regulated?
Yes, contingent deferred sales loads, like other mutual fund fees, are regulated by bodies such as the Securities and Exchange Commission (SEC) under the Investment Company Act of 1940 and by FINRA. These regulations aim to ensure transparency and fairness in mutual fund sales practices and fee structures.1