Two share classes of the same semi-liquid fund, the holding period at which they cross, and what each one pays the distributor.
An upfront fee costs less than an ongoing servicing fee for any client who holds beyond the break-even period, found by compounding both: (1 − upfront) × (1 + r)n = (1 + r − servicing)n. On an illustrative semi-liquid fund returning 8.0 per cent before share-class fees, a 3.0 per cent upfront fee and a 0.85 per cent annual servicing fee cross at 3.85 years, not the 3.53 years that dividing one by the other suggests. After ten years the upfront class is worth 99,254 more on a 1,000,000 subscription.
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Semi-liquid funds sold through wealth channels usually offer the same portfolio in several share classes, priced differently for different distribution arrangements: one with a placement fee at subscription, one with an ongoing servicing fee paid to the distributor, an institutional or fee-based class with neither. An advisor choosing between them, and a fundraiser designing them, both need the same number: how long must the client hold for the upfront class to be the cheaper one?
| Input | Value |
|---|---|
| Subscription | 1,000,000 |
| Return of the fund after fund-level fees, before share-class fees | 8.0% |
| Upfront class: placement fee deducted at subscription | 3.0% |
| Servicing class: annual fee on NAV | 0.85% |
In the upfront class, 30,000 goes to the distributor on day one and 970,000 is invested. In the servicing class, all 1,000,000 is invested and the class earns 8.0 − 0.85 = 7.15 per cent a year.
| Year | Upfront class | Servicing class | Difference | Servicing fees paid to date | Annual return, upfront | Annual return, servicing |
|---|---|---|---|---|---|---|
| 1 | 1,047,600 | 1,071,500 | -23,900 | 8,500 | 4.76% | 7.15% |
| 2 | 1,131,408 | 1,148,112 | -16,704 | 17,608 | 6.37% | 7.15% |
| 3 | 1,221,921 | 1,230,202 | -8,282 | 27,367 | 6.91% | 7.15% |
| 4 | 1,319,674 | 1,318,162 | 1,513 | 37,823 | 7.18% | 7.15% |
| 5 | 1,425,248 | 1,412,410 | 12,838 | 49,028 | 7.34% | 7.15% |
| 7 | 1,662,410 | 1,621,606 | 40,804 | 73,897 | 7.53% | 7.15% |
| 10 | 2,094,157 | 1,994,903 | 99,254 | 118,275 | 7.67% | 7.15% |
A client who leaves after one year has paid 239 basis points more in the upfront class. One who stays ten years has paid 52 basis points a year less. The classes cross between years three and four.
0.97 × 1.08n = 1.0715n
n = ln(1 − upfront) ÷ ln((1 + r − servicing) ÷ (1 + r)) = ln(0.97) ÷ ln(1.0715 ÷ 1.08) = 3.85 years, about 46 months
In Excel: =LN(1-3%)/LN((1+8%-0.85%)/(1+8%)). The shortcut =3%/0.85% gives 3.53 years.
The shortcut is wrong because the servicing fee is charged on the opening NAV, before the year's growth. A fee of 0.85 per cent of the opening NAV is only 0.79 per cent of what the NAV would have reached by year end, so the servicing class falls behind the upfront class by 0.79 per cent a year, not 0.85. The 3.0 per cent upfront fee takes longer to repay than the simple ratio says, by about four months here.
| Upfront fee | Servicing 0.50% | Servicing 0.85% | Servicing 1.00% |
|---|---|---|---|
| 2.0% | 4.4 | 2.6 | 2.2 |
| 3.0% | 6.6 | 3.9 | 3.3 |
| 3.5% | 7.7 | 4.5 | 3.8 |
The fund's return moves the answer only a little: at 3.0 and 0.85 per cent, the crossing is 3.71 years at a 4 per cent return and 4.00 years at 12 per cent. The holding period is the variable that decides, which makes the advisor's honest estimate of how long the client will stay the most important input in the choice.
The distributor's side of the same choice. Over five years the servicing class pays the distributor 49,028 on this subscription. Discounted at 8 per cent that is worth 38,737 today, against 30,000 upfront. A distributor confident of keeping the client is better paid by the trail; one expecting a short holding prefers the certainty of the upfront fee. Neither preference is the client's.
Set the two compounded values equal and solve for the holding period: 3.0 per cent upfront against 0.85 per cent a year crosses at 3.85 years, and a client expected to stay longer is better served by the upfront class. Distributors are also often paid a share of the management fee itself, calculated on NAV, which is the subject of how retrocessions are calculated. The Private Wealth Fundraiser covers raising private markets capital from wealth managers and private banks, and the free workbook for this case forecasts how a wealth channel's flows and redemptions develop over seven years.
Because a servicing fee of 0.85 per cent of opening NAV is only 0.79 per cent of what the NAV would have reached by year end, so it erodes the client's position relative to the upfront class at 0.79 per cent a year, not 0.85. Dividing 3.0 by 0.85 gives 3.53 years; the compounded crossing is 3.85 years.
Slightly less so, in fact. With higher returns the servicing fee is a smaller fraction of each year's gross growth, so the crossing comes later: 3.71 years at a 4 per cent gross return, 3.85 at 8 per cent and 4.00 at 12 per cent. The effect is small; the holding period is what decides.
Usually the servicing class, if the client stays. On 1,000,000 the 0.85 per cent fee pays 49,028 over five years, worth 38,737 today at an 8 per cent discount rate, against 30,000 upfront. The upfront fee is certain and immediate; the trail depends on the client keeping the investment.
This article is one calculation from The Private Wealth Fundraiser. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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