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Revenue Sharing Sordid' But Essential: Morningstar

Even though revenue-sharing payments come out of a fund's own coffers, the common practice hurts investors because of the bias it creates, attests Morningstar columnist Eric Jacobson. "The reality is that fund companies pay up for precious access to brokers, and those brokers are almost always limited to selling funds that have paid up," Jacobson said. For instance, he points out that Merrill Lynch notes that "funds that do not enter into arrangements with Merrill Lynch are generally not offered to clients."

However, Jacobson admits that it is difficult to place blame on mutual fund companies for participating in revenue-sharing arrangements because a good chunk of fund companies sell their funds via intermediaries and "those who try to stay above the fray' would find themselves locked out."

In fact, even though directed brokerage has now been banned and revenue-sharing agreements are under close regulatory scrutiny, financial advisers will play an increasingly significant role in mutual fund sales in the coming years, according to a report from Financial Research Corp. The company predicts that direct sales to investors will drop from 15% in 2004 to 10% in 2009, while adviser-assisted sales will rise from 57% to 61% during the same period,

Banning revenue sharing altogether wouldn't solve the problem, either, Jacobson said, because it would most likely lead to higher front-load fees to compensate sales agents. At least for now, Jacobson said, improved disclosure is sure to help investors greatly in figuring out the motivations of their brokers.

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