Low-Cost Load Funds Make Sense for Some

One detail that figures prominently in our screens every week is fees, since they can eat into performance. We like to keep them to a minimum. So our finalists always have expense ratios — the amount they charge annually for their services — that come in below those of their competitors. More importantly, though, each week we eschew funds that levy sales loads. To us, these fees instantly put shareholders in a hole.

But by avoiding load funds we are neglecting to cover 85% of the 21,597 funds and share classes listed in our Lipper database. Many of those are top-notch offerings. So, this week we start our semiannual look at these funds. We began with a universe of 18,325 names, our biggest group of the year, and narrowed that list with our usual performance and expense-ratio criteria. Below are the 11 large-company stock funds that made the cut.

Fund companies are the ones imposing a load on investors, but that money eventually finds its way into the pockets of the financial advisor who sold the fund. It's a circular relationship that, if everything works out right, winds up rewarding each party involved. The advisor points his client toward a fund that (hopefully) posts decent returns year in and year out. In return, the advisor gets compensated for his advice and the fund company is happy with the new business. Loads can be as little as 1% of invested assets or as much as 5.75%. They are usually tacked on when you buy the shares (front-end load) or when you ultimately sell the position (back-end load).

The trick for investors is holding onto a fund long enough so that returns eventually make up the ground lost by paying the load in the first place. If you pay an initial 5% sales load that means the fund you just bought would have to earn an extra 1% each year for five years compared to similarly-performing no-load competitors before you would be on a level playing field. That's a tall order, indeed, and one of the reasons why we limited this week's screen to large-cap funds. Large-cap funds tend to be core holdings that sit in a portfolio for decades. That's plenty of time to wash away the effects of paying a load. Indeed, the funds on our list have returned 6.9% since 1998 vs. roughly 4% for the S&P 500. (In the weeks to come we will do additional screens that look at load funds in other categories.)

Before you go paying a load, though, weigh your options. In most cases, fund companies offer ways to get around paying a load. For example, some advisors who have a certain amount of assets with a particular fund family can buy "load-waived" share classes. Retail investors may also be able to purchase those shares if they invest large amounts or open an IRA account with the company and contribute to it on a regular basis. Some fund companies also offer "break points" where a load is gradually decreased over time as an investor deposits more and more of his or her assets. (Company-sponsored 401(k) plans get a free pass, too.) One thing to consider: If you do buy a fund that charges a load, make sure you can move into another offering within the same fund family without getting hit with additional fees. After all, if your fund bombs you want the option to invest in something else.

"You are truly buying and holding for a period of time," says Dean Harman, owner of Harman Wealth Management in The Woodlands, Texas. "[Investors] are taking quite a bet that XYZ fund will be a top performer for the next 25 years."

American Funds, a fund family with $900 billion in investments and over three dozen offerings, is the most popular load-fund option in the industry. The company's low costs and team approach to stock picking have resulted in top-notch returns. American Funds Fundamental Investors (ANCFX), a fund that continuously makes this screen, has returned an average annual 8% over the last decade. That's better than 95% of its competitors. Davis New York Venture (NYVTX) is joining the list this time around. This fund's knack for picking depressed stocks with good cash earnings has served its shareholders well. It's in the top 12% of its Morningstar category over the trailing decade. Those two funds charge 5.75% and 4.75% loads, respectively.

The Criteria: This week's screen is dedicated to load funds. The ones that made our cut were open to new money, charge an annual expense ratio less than 1.5% and require a minimum investment less than $5,000. Their performance track records put them in the top 20% of their category over the trailing three-, five- and 10-year periods. We limited the list to large-cap funds, but we'll be looking at other load fund groups in the coming weeks.

Also See:

Consistent Returns Can Reveal Good Funds

Low Fees Alone Don't Make a Fund a Buy

Only Two Microcap Funds Make Our Cut