SM: Fund Fees and the Pimco Effect

The business of running and selling traditional, actively managed mutual funds is already under stress, thanks to exchange-traded funds. The new Pimco Total Return ETF (TRXT), debuting March 1, seems likely to only add to the pressure.

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Should the ETF version of Bill Gross's Pimco Total Return prove a success in attracting investors, the pressure will build on competitors to follow suit.

This is an unpleasant prospect for companies without Pimco's tremendous scale. It means entering a business with typically lower profit margins than traditional funds because of the low fees common among ETFs.

To be sure, it is premature for ETF boosters to declare complete victory. That is especially the case with stock funds, where the daily disclosure of holdings by ETFs is a big stumbling block for fund managers wary of tipping their hand as they buy or sell. And active managers even Bill Gross still need to prove worthy of investor money with market-beating performance.

But the popularity of ETFs is threatening to kill off what was long a linchpin of mutual funds: 12b-1 fees.

Named after the 1980 Securities and Exchange Commission rule that created them, 12b-1 fees allow mutual funds to charge their investors for sales and marketing costs. Critics say 12b-1 fees are sales commissions in disguise. They're commonly used to pay for "trailing" commissions brokers receive when clients keep their money in certain share classes. Even "no-load" fund companies use them, to pay discount brokerage firms to carry their products in fund supermarkets. (The SEC has tried to address some concerns by proposing a tweak to its rules and establishing a "12b-2" fee for "marketing and services.")

Most ETFs, including the Pimco Total Return fund, don't levy 12b-1 fees, which helps keep their expenses low. Marketing costs must come out of the fund companies' own pockets, not fund assets.

To some degree, 12b-1 fees have dwindled in importance as the brokerage world has shifted toward flat-fee accounts and away from commissions. But for fund companies still addicted to using 12b-1 money to entice advisers to sell their funds, launching an ETF would mean going cold turkey.

"To grow an asset-management firm, you have to have distribution," says Morningstar Inc.'s Eric Jacobson. "Not having a 12b-1 fee makes it harder." In part because of the lack of 12b-1 fees, ETFs have tended to be investments that are "bought" rather than "sold."

The ETF business world doesn't have the sales infrastructure to get brokers to look at new funds or help keep investors in a company's funds when performance turns south, says Brian Posner, a longtime fund manager and industry executive. "If you are one of the managers with the umpteen mediocre funds, putting an ETF wrapper on your product may be necessary but not sufficient," he says.

Pimco has a well-known brand name, solid long-term performance, and a strong base of clients and advisers. But for companies without those strengths, ETFs will be a struggle.

Send questions and comments to Mr. Lauricellaat tom.lauricella@wsj.com.