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The future for fund charges

Investment | Unit Trusts

By Justin Modray, published 31 July 2012.
Helpful? 84

Fund charges could change significantly over the next couple of years, how might you be affected?

From 31 December 2012 commissions will be banned on all new product sales, including funds, via financial advisers. While this change, part of the FSA's wider Retail Distribution Review (RDR), won't initially extend to sales where advice isn't given, it likely will further down the line. The FSA also has imminent plans to prevent fund managers from paying fees to fund platforms/supermarkets.

How might all this affect the fund charges we pay moving forwards?

First, a quick recap

A typical fund (unit trust) has the following charges:

Initial charge
Between 3% - 5%, of which 3% is paid as a sales commission.

Annual charge
1.5%, of which 0.5% is paid as sales commission, 0.25% to a fund platform and 0.75% kept by fund manager (there's a bit extra on top of the 1.5% for things like custody charges that we'll ignore for simplicity).

For more details take a look at my earlier article

Funds sold with financial advice

From 31 December 2012 sales commission will be banned where financial advice is given. This means we can expect fund charges to typically fall by 3% initially and 0.5% annually.

Advisers will instead charge fees, agreed with their client. These may be paid directly to the adviser or, with the client's permission, via the fund (or, more practically, a fund platform), which will increase its charges accordingly. So we could end up with pretty much the same position as now (i.e. the adviser taking 3% initially and 0.5% annually from the fund) provided their client has signed a piece of paper giving the ok.

In practice I hope we see a prevalence of lower overall fund charges and lower cost fixed fee financial advice, which should give the majority of customers a better deal. I'm confident about the former, but less so about the latter.

Funds sold without financial advice

Funds sold on an execution-only basis (e.g. via discount brokers) will be allowed to continue paying sales commissions, so in theory no change to current charges. However, the FSA seems minded to ban commissions via this route too (which makes sense) - my guess is this'll happen by 2014. Although such change will probably only apply to new sales rather than existing (so called 'legacy') business.

Fund platform/supermarket fees

At present most fund platforms make their money by charging fund managers rather than investors. The typical charge seems to be around 0.25% a year, but as most platforms don't disclose these they're somewhat shrouded in secrecy...I've heard rumours of one large platform/discount broker demanding a total of 0.85% a year - effectively 0.5% commission and 0.35% platform fee.

The FSA has said it wants to ban fund manager payments to platforms, with investors paying an explicit fee instead. Again, greater transparency makes sense and should give most investors a better deal (provided they shop around). The tentative date for this change is 31 December 2013. If the rule change goes ahead we can expect to see fund charges fall by around 0.25% a year.

The overall impact

Put all these changes together and you come up with a simple conclusion. Fund charges for consumers should fall to 'institutional' levels - i.e. the same lower level enjoyed by professionals - where no sales commissions or platform fees are incorporated into charges. For most funds this should mean no initial charge and an annual charge of around 0.75%. Consumers will then pay an explicit fee to use a fund platform and for any discount broking or financial advice services taken. Let's hope the necessary rules are all introduced by 2014 at the latest.

However, competition in the marketplace might drive through (voluntary) change more quickly, as a couple of platform/discount brokers have already introduced this type of arrangement. Both Interactive Investor and Alliance Trust Savings rebate sales commissions and platform fees, instead charging annual platform and dealing fees. While I'd prefer them to use institutional versions of funds (as it's simpler and probably a bit cheaper), this broadly gives the same end result and provides very good value for the majority of investors.

Note: As I write Club Finance has also announced a new charging deal with full rebates, I'll update the ISA discount broker comparison shortly.

A problem for traditional discount brokers

Such new charging structures tend to make traditional discount brokers (who keep most/all trail commission) look expensive by comparison. And if/when commission on execution-only sales is banned these brokers could find themselves struggling to stay in business. Instead of receiving 0.5% annual trail commission from fund managers, they'll have to charge their clients a fee instead. Unless the broker is providing great value-added service (which is rare) then why would their customers want to stump up cash for something they probably thought was 'free' in any case?

If the ban only applies to new fund sales (likely) these brokers could continue to take trail commission on existing business, but I still think they'll struggle. Running two different charging structures would confuse customers. And more and more of those customers will probably wake up and realise they can get a much better deal elsewhere in any case.

And a squeeze on discount brokers with their own platform

Discount brokers who've invested heavily in their own fund platforms, such as Hargreaves Lansdown (HL) and Bestinvest, could suffer a double whammy if fund manager platform payments are also banned. These brokers are currently quids in, as they pocket both trail commission and platform fees, giving a potential gross margin of about 0.75% or more. After they've rebated some trail commission, usually around 0.15%, this leaves them with c0.6% of the 1.5% annual fund charge - a very healthy margin - in fact Citigroup estimates HL's average margin for Vantage clients even higher at 0.68% (partly because it doesn't rebate trail commission on its SIPP). And that's excluding the margin these companies make from paying paltry cash interest rates on their platforms. Of course, it costs money to run a platform, but margins like these are the envy of the industry.

A ban on fund manager platform payments and execution-only sales commission could see HL's and Bestinvest's juicy margins shrink overnight. They'll almost certainly have to hit their customers with explicit fees for holding funds, which will likely be met with major resistance given these services are largely perceived as 'free' at present. And, even if such fees were widely accepted, I think they'll struggle to squeeze the equivalent of 0.6% or more a year out of their customers.

Throw in the FSA requiring platforms to allow 're-registration' by the end of this year (removing barriers to move your investments 'as is' from one platform to another) and you can see why these brokers/platforms might be nervous...

So potentially bad news for some discount brokers but good news for customers?

Yes. There's a danger some fund managers will try and get away with not passing on the full extent of commission and platform fee savings to customers, but I expect this to be the exception rather than the norm. And, rest assured, we'll kick up a fuss against such offenders!

Many financial advisers will probably try and charge commission equivalents as fees taken from funds, meaning no real change for their customers (if they agree to such fees). I think there's a gap in the market for good, low cost fixed fee advice - but given the FSA seems bent on pushing up IFA operating costs whether such a service is viable on a large scale remains to be seen.

And expect more discount brokers to either follow the Interactive Investor/Alliance Trust Savings type model or attempt to add value with fund research tools and features (e.g. Dennehy Weller's fundexpert website). Neither will be a guarantee of success, but failure to do anything could see them sink not swim if the FSA does ban commissions on execution only sales.

For once the customer stands a fighting chance of coming out on top. Something that doesn't happen very often in financial services...

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Readers' Comments (7) - To post a comment please register or login .


Comment by ivanopinion at 3:47pm on 06 Aug 2012:

Glad to hear that you will be kicking up a fuss if some fund managers decide to get greedy and charge more than 0.75% AMC on their new commission-free classes of units. It might be good if Candid Money kept a tally of the new AMC's as they are announced.


Comment by ivanopinion at 4:14pm on 06 Aug 2012:

It is going to be interesting to see how the discount brokers and platforms/supermarkets decide on their pricing strategies. We have already seen a huge outcry when Interactive Investor introduced an administration fee. It would seem that they had large numbers of account holders who had relatively small portfolios with Interactive Investor and were not trading frequently, so an administration fee of £20 per quarter was proportionately very large. Most of these investors have presumably switched to other platforms/brokers. But is any platform/broker going to be able to make a reasonable profit from this sort of investor without having an administration fee? They can no longer rely on this type of investor having a few investments in funds on which they get to keep the trail commission and perhaps also the platform commission.

They could perhaps set an administration fee on a percentage basis. If HL makes an average of 0.6% on each customer, let's assume other less well known platforms are willing to accept an average of 0.5%. That might work for those small investors, because 0.5% on a portfolio of, say, £5,000 would only incur a fee of £6.25 per quarter, which would probably be acceptable to the investor. Trouble is, a big investor with a portfolio of, say, £300,000 would not necessarily be happy to be paying £1500 per year. They might be better off switching to a platform which has a flat fee model. If you lose all the big portfolios, then you are left with lots of small investors on which a 0.5% administration fee is not going to add up to a lot of money. That might not be enough to cover your costs.

Perhaps we will see platforms/brokers rely primarily on dealing fees for their profits. I wonder how many trades per year does the average investor make? Probably a lot more than they would plan to make. 10 trades at £10 per trade is £100, which is not bad. Many people trade much more frequently, which is hundreds of pounds of income per year.


Comment by ivanopinion at 7:17pm on 09 Oct 2012:

It should be noted that, strictly speaking, Interactive Investor gives a full rebate of all the trail and platform commission that it receives, but this is not necessarily the same as the trail and platform commission that the fund pays. The reason is that Interactive Investor are using a white label version of Cofunds. (That is, it is branded Interactive Investor, but “under the hood" it is Cofunds.) Cofunds keeps some of the commission (I am guessing specifically this is the platform commission), but passes most of it to Interactive Investor. This explains why the maximum rebate for Interactive Investor seems to be 0.64%. On most actively managed equity funds the fund will be paying 0.5% trail commission and 0.25% platform commission, but it looks like Cofunds is keeping 0.11% and passing on 0.64% to Interactive Investor.

It remains to be seen whether this is viable in the long run. Once platform commission is banned, there will no longer be any commission for Cofunds to keep, so presumably they will demand some sort of fee from Interactive Investor, who will in turn have to charge a fee to the investor. This is not going to be covered by the existing £20 per quarter fee, unless the investor has a fairly small overall holding with Interactive Investor.


Comment by justin at 10:38am on 12 Nov 2012:

Thanks for pointing out Interactive Investor using the Cofunds platform for their fund investments. I've discussed this with Interactiove Investor and they seem confident their charging will not change as/when the FSA bans payments from fund providers to platforms. However, I'm a little less convinced - if/when Cofunds no longer receives income from fund providers it'll have to charge investors, I doubt Interactive will pick up the bill in full.


Comment by ivanopinion at 4:20pm on 12 Jan 2013:

We are starting to see the reaction by fund managers. Many of them have launched completely clean versions of their funds. ATS provides a list of the ones they stock here:
http://www.alliancetrustsavings.co.uk/rdr-updates/

There's a more comprehensive list of low cost funds (sold by TD Direct) here: http://lt.morningstar.com/e4e1fvybwy/fundscreener/default.aspx.
You need to choose the first option in the first drop-down list, then select the right fund manager and it will give you a list.

Both lists include funds that are only semi-clean (no trail commission, but AMC is 1%, so presumably it still pays platform commission). eg, Invesco Perpetual.


Comment by ivanopinion at 4:55pm on 12 Jan 2013:

No sign of companies like Hargreaves Lansdowne making available the clean fund classes. They obviously plan to continue receiving most of their income covertly for as long as they are allowed to do so. However, will punters continue to let themselves be ripped off now that it is even more obvious than before? For most funds you can now buy the version that is eroded by 1.5% AMC each year (and receive a tiny rebate from HL) or you can go to Interactive Investor, ATS or TD Direct and buy the same fund in a version which has an AMC of only 0.75%. Unless you have a small portfolio or you trade very frequently, it is now so obvious that you would be better dumping HL. (With a portfolio of, say, £100,000, you would probably save £500 or more, per year.)


Comment by justin at 11:44am on 13 Jan 2013:

Thanks for pointing out clean share classes ivanopinion. Just putting the finishing touches to a dynamic platform comparison tool to help investors more easily compare platforms, especially re: overall charges - will be ready in a week, more details v shortly.

Meanwhile, 'clean' classes that just remove trail (e.g. Invesco Perpetual) are not very fair on customers when platforms don't take a platform fee, e.g. Alliance Trust & TD. Nice earner for Invesco Perpetual but poor negotiating by those platforms. Trouble is, Invesco Perpetual High Income is so popular platforms need to include it, so suspect Invesco Perpetual have the upper hand in negotiations,for now at least...