Crouching tiger, hidden charges: Investing costs

The cost of investing is set to fall after the City watchdog launched a fresh crackdown on hidden charges – but investors could yet lose out if fund firms take the opportunity to boost their profits.

Fund supermarkets and platforms are moving to so-called “clean” charging structures after the Financial Conduct Authority (FCA) confirmed they will have to disclose exactly how much investors pay for their services.

The move came just months after a ban on commission payments from providers to financial advisers selling their funds finally came into force.

The hoped-for outcome of the two reforms is a new era of transparency, in which consumers know exactly what they’re paying both for their investments and for advice on them.

Patrick Connolly, head of communications at adviser AWD Chase de Vere, said: “The overriding concerns of the regulator are to put  investors first and provide them with complete transparency so they can see the cost of everything they are paying for. It is difficult to argue with these intentions.”

The latest rules, coming into force next April, will end the practice of fund providers paying commission to the websites selling their funds.

Those sites, known as fund supermarkets or platforms, offer one-stop shop access to products from various fund providers. Under the established model, platforms take commission from fund providers, which itself comes out of the charge paid by the investor.

A slice of that commission is paid back to the investor in the form of a rebate, so reducing their costs. However, not all platforms disclose how much they give back to investors, while rebates vary among those that do reveal the rebate amount.

It was concerns around this lack of transparency that prompted the regulator to act. It said commission means “some platforms are able to give the impression they are offering a free service, which means that the investor may not understand the true cost”. A similar motivation – eradicating commission bias – was  behind the retail distribution review that came into force on 31 December, 2012 under which commission-based advice was outlawed.

So what does it all mean for investors? Can the post-commission era not only make it  easier to understand the costs of investing, but also reduce those costs?

Removing the “bundled” charging structure where the various charges (including the AMC and the platform fee) were all rolled into one figure of typically 1.5 to 2 per cent a year is  welcome, said Tom Munro, owner of Tom Munro Financial Solutions in Larbert: “Unbundling the cost separates each component so the investor clearly sees who gets what, allowing them to make an informed decision.”

In theory, investors should pay less under commission-free (“clean”) pricing, even without rebates. The typical annual management charge (AMC) under the current bundled system is around 1.5 per cent, including commission that is part-paid back to the investor. Under clean charging the AMC tends to be around 0.75 per cent – the 1.5 per cent minus the 50 per cent usually paid as commission and the 0.25 per cent rebate paid to the  platform.

“The new charges for clean share classes have been largely fixed at 0.75 per cent a year for little reason other than because this has  always been the standard charge taken by fund managers in the past,” said Connolly.

Let’s compare the impact on returns of the two types of pricing, using the example of a £10,000 Isa investment over five years at an anticipated growth rate of 5 per cent a year. Where an investor pays an AMC of 1.5 per cent, minus a 0.25 per cent rebate, the return after five years would be £29,956, according to the calculator at www.charles-stanley-direct.co.uk. Under a clean charge of 0.75 per cent the investor would get £30,389 back, an extra £433 in returns.

Munro predicts that the move to clean pricing will result not only in lower fund charges, but also in lower platform charges as a more level playing field is created. “This new landscape can only benefit the investor who has sadly for many years been an afterthought in all the complexities and scandals most of which have been self-generated by a greedy industry,” he said.

That can’t be taken for granted, however. One concern is that some platforms and fund providers may take the opportunity to widen their margins in the process of moving to clean pricing. “The introduction of clean share classes has seen an overall rise in the costs paid by investors as with the loss of rebates investment companies are now taking bigger margins,” said Connolly.

The regulator has already warned the industry against using the changes as a reason to increase their fees.

Fund managers enjoy bigger margins on clean share classes, estimated by Connolly at between 30 and 35 basis points. In contrast, margins for platforms under this model are closer to 6 or 7 basis points.

Among the firms to have shifted to clean share classes is platform giant Cofunds. It now levies a flat fee of £40 a year, plus tiered platform charges of 0.29 per cent for investments up to £100,000; 0.26 per cent for investments up to £250,000; then 0.23, 0.2 and 0.15 per cent for investments up to £500,000, £1 million and above £1 million respectively.

With fund charges of typically 0.75 per cent included too, the total cost for smaller investors is often cheaper under the current bundled system.

But there is now strong downward pressure on charges, according to Connolly.

“The UK has the most expensive active management charges in the world, and we expect and encourage the launch of ‘super-clean’ share classes which will help drive charges down,” he said.

Super-clean charges would see investment companies giving investors back some of the margin they’ve gained in the move to unbundled charging, Connolly added.

“We expect annual charges on these share classes to be typically between 0.65 and 0.7 per cent,” he said. “This would provide better value and coupled with greatly improved transparency would mean that the FCA will have achieved their objective of putting investors first.”

l For more information see www.comparefundplatforms.com/ to assess the total cost of investing through the different fund platforms and discount brokers.

From fund platforms to clean shares – what does it all mean? A guide to cutting through all that jargon

It’s been dubbed the year of the DIY investor, as more people than ever skip the middleman and buy their investment products online.

Those sites, usually known as fund supermarkets or platforms, are benefiting from rules introduced at the end of 2013 that featured a ban on commission payments from providers to financial advisers for selling their products.

One result was a shrinking of the advice market, leaving millions without access to advice or unwilling to pay for it upfront.

Online services that allow investors to buy direct without taking advice, such as FundsNetwork, Hargreaves Lansdown and Alliance Trust Savings, have flourished.

They must now adapt to a crackdown on the commission paid to them by fund providers, as explained in the main article on this page, but it’s unlikely that their rapid growth will be checked.

Yet for many investors the world of fund platforms remains a baffling one.

So here we look at some of the main terms and explain what they really mean.

Annual Management charge

One of the more self-explanatory examples, referring to the annual fee levied by an investment fund or trust.

Bundled charging

Where commission and platform fees are included in the annual charge levied by fund managers.

lClean share classes

Fund charges with commission and platform fees stripped out (as required under new rules effectively banning the bundling of platform and fund charges).

Discount broker

“Execution-only” intermediaries, usually online, who can facilitate investments without offering advice. The discount refers to the rebate of the commission that the broker receives from the fund manager.

Fund supermarket

One-stop-investment fund-shops, essentially.

These are online services allowing investors to buy funds from different providers across the market through a single account. Supermarkets can hold (but not manage) investments such as those within wrappers such as individual savings accounts (Isas) and self-invested personal pensions (Sipps).

Fund Platform

Similar to supermarkets except they are primarily used by financial advisers to manage portfolios on behalf of their clients.

RDR

The retail distribution review, which took effect on 31 December, 2013. The reforms under the RDR include a ban on commission to financial advisers from investment providers and more stringent qualification requirements for advisers.

lRebates (cash)

The amount of the AMC that is paid back to platforms by fund providers, as commission. Usually around 0.75 per cent (half the AMC). Platforms keep most of it but pay a cut to investors to reduce their costs. Cash rebates will be banned next April.

Rebates (unit)

Where charges are rebated in the form of additional units or shares. These are not being banned.

Total Expense Ratio (TER)

The drag on performance resulting from the annual fund costs combined, including not only the AMC but also charges such as admin fees.