RDR changes will be messy, but investors will be better off, says Cris Sholto Heaton
Even if you don't use a financial adviser, the RDR will still affect you, because banning commission will mean a major change in the way that fees are charged on the most popular type of investment fund of all the unit trust. Here's what's happening and how to make sure you are paying as little as possible.
First, let's recap on the jargon. To get broad exposure to a wide range of companies, most investors buy funds. What happens is you and a lot of other investors give your money to a fund management group. This pool of money is invested in a portfolio of underlying stocks, bonds, or other assets. The most popular types of funds are unit trusts and open-ended investment companies (OEICs).
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There is little practical difference between the two, so we'll use unit trusts' to apply to both. These are open-ended funds, which means they don't trade on the stock exchange. Instead, you buy units from the fund-management company (either directly, or through an adviser or fund supermarket). The price is directly linked to the underlying value of the portfolio.
Why are unit trusts so popular? Mainly because they have until now paid commission to independent financial advisors (IFAs). Other types of collective investments such as investment trustsand exchange-traded funds (ETFs see page 10) don't pay trail commission so the direct impact of RDR on unit trusts is greater than for other investment vehicles.
Trail commission is usually paid out of the annual management charge (AMC), which is taken from the fund by the fund manager. This fee is typically around 1.5%. The fund manager normally keeps 0.75%. If you buy via an IFA, he or she would usually get around 0.5% in trail commission (we'll get on to where the final 0.25% goes in a moment).
But as IFAs won't get trail commission on new investments from next year, fund managers are now adjusting their fees. They are able to offer the funds without the part of the fee that was once paid as trail commission. These are referred to as clean share classes' so in the example above, the old share classes charge a 1.5% AMC, while the clean share class will charge 0.75%.
Don't expect costs to plunge
Sound like good news? Not so fast. Sadly, fund managers are not (as yet) cutting the fees on all share classes. If you go direct to a fund manager to buy a fund, you'll usually still pay the full 1.5% AMC: the manager will just keep the extra 0.75% that would have been paid out as commission. Most firms seem to hope to keep this up even after RDR kicks in. So the clean' share class will only apply to investments made via certain channels which means you'll end up spending money on other fees instead. B
ut if IFAs are no longer getting paid to recommend unit trusts, then won't they start looking at cheaper, better-performing alternatives for their clients, such as investment trusts and ETFs? Some might. But it's also possible that many IFAs will simply be less interested in choosing any funds at all. Some already feel that regulators are looking so closely at their investment portfolios that it's not worth taking the regulatory risk, particularly as this side of the business may be less profitable after RDR.
So some IFAs may simply outsource investment decisions to specialists, or increase their use of multi-asset or multi-manager funds, where they rely on a fund manager to allocate money between different assets and regions. These funds tend to be expensive another reason why you should consider taking control of your own money rather than relying on an adviser to do so (for more on basic portfolio building, see page 12).
How fund supermarkets get paid
If you're already a DIY investor, you might wonder how any of this affects you. This is where we come to the second link in the commission chain. To understand how this works, you need to consider how you actually invest in a fund. Few investors go to the fund management firm direct. Instead they trade via a fund supermarket (see below for a full definition). These offer access to hundreds of different funds in one place. Better yet, they can often secure better rates from fund groups due to their bulk buying power it's like Tesco's for investors.
When you invest through a fund supermarket (whether through an IFA using a platform, or by yourself using a discount broker), it receives the trail commission from the fund. It keeps some of this for itself, before passing the rest of the commission on. This is where the missing 0.25% in our IFA example above goes it's the platform' fee.
So of the original 1.5%, the fund manager keeps 0.75%, the platform keeps 0.25% and 0.5% goes to your IFA or discount broker (the breakdown for some funds on some platforms will vary).
Most IFAs currently keep the whole 0.5% they get. Discount brokers will typically pass some back to you (after all, they're not offering you advice usually, they're just carrying out your trade instructions). The best return virtually everything, while some hold on to a large chunk of the fee.
Your broker's charges will change
With RDR, this will all have to change. As well as banning commission to IFAs, the Financial Services Authority is looking at scrapping it for fund supermarkets too. So it's not just IFAs who need to find new ways of charging fees and covering their costs the fund supermarkets will have to levy fees on your investments too. As a result, you are likely to see several smaller fees being charged by fund supermarkets, rather than one chunk of trail commission. It might be more complex, but it should give you a better idea of who is taking what at which stage in the process.
Since the platform rules won't take effect for another year assuming they go ahead it's not yet clear who will charge what. But some companies are already introducing unbundled pricing' (ie, each individual cost is separated out, rather than bundled' together). For the platforms, typically this consists of a small annual flat fee, plus a percentage of assets. The discount brokers will then add their own fees on top of this.
Many firms have not yet announced pricing, but it's likely there will be charges for both buying and selling funds, or an added AMC or both. For example, discount broker Interactive Investor is now charging £20 a quarter (which includes two free' trades), with purchases or sales charged at £10 a trade (or £1.50 for regular investments). Its service uses the Cofunds platform, so this will be on top of Cofunds' own unbundled charges, which will be a £45 a year flat fee, plus an annual management charge of 0.29% on portfolios under £100,000, dropping in stages to 0.15% for portfolios over £1m.
Cavendish Online, which uses FundsNetwork, hasn't announced full details, but it currently levies no direct fees and gets a 0.05% slice of trail commission out of FundsNetwork's own 0.25% platform fee; the firm has said that it expects to keep a similar arrangement once RDR comes in.
Among the firms that are both platform and broker, Alliance Trust is charging £10 (plus VAT) a quarter, with trades charged at £12.50 a go. Clubfinance has launched a new service with no dealing costs and a total annual fee of 0.35%, including platform costs. Sippdeal will charge 0.2% a year on portfolios of up to £1m, with the fee dropping in stages after that, to as low as 0.05% for portfolios of more than £2m. Trades are charged at £3.95. (Note that all the above fees are for a general investment account or individual savings account and that a self-invested personal pension will often carry extra charges.)
So, on balance, it appears the best platform/discount broker combinations will end up charging around 0.25%-0.35% or lower, depending on portfolio size, although some providers will undoubtedly be more expensive. If fund managers continue charging 0.75% on clean classes, the total AMC is likely to be around 1%, in line with today. But hopefully costs will fall further.
The demise of trail commission should mean that fund supermarkets have every reason to start carrying ETFs, investment trusts and funds that refuse to pay trail commission. These are generally cheaper than unit trusts. Being forced to compete directly with these lower-cost funds should pressure fund groups to cut charges. The fund supermarkets may also push for lower fees. They no longer have any reason to support 1.5% AMCs as they are no longer getting part of these in trail commission. If they offer funds at lower fees, they may be able to win business from other platforms.
With everything still in flux, it's hard to know as yet which platforms and brokers will come out with the best deal although Cavendish has long been a cheap option for small portfolios and is likely to try to stay that way, and Sippdeal's new charges look promising. For now we would avoid jumping from provider to provider in response to fee changes until it becomes clearer over the next year. But while RDR is set to be messy and charges may be more complicated, savvy investors will ultimately be better off.
What is a fund supermarket?
The term fund supermarket' is often used to refer to two different things. One is the platform' this is the infrastructure that deals with the fund management companies. The other is a discount broker' that the end investor uses to access the fund supermarket. For example, two of the major standalone UK platforms are Cofunds and FundsNetwork, which each offer more than 1,000 funds. IFAs can access these platforms directly, while DIY investors will go through a discount broker such as Cavendish Online (which accesses FundsNetwork) or Interactive Investor (which accesses Cofunds). Some firms combine both roles Hargreaves Lansdown runs its own Vantage platform, for example, while Alliance Trust Savings has an inhouse platform called i.nvest.
