The FSA’s Retail Distribution Review (RDR) is set to shake up investment costs in the UK enormously over the next year or so. With effect from January 2013, financial advisers will no longer be able to receive trail commission – ongoing payments from fund groups – on new investments.
More importantly for DIY investors, the FSA is then likely to ban fund platforms for receiving trail commission with effect from January 2014. This means that the fees currently charged by many execution-only firms will have to change drastically.
Once that happens, many of the details in this site’s UK fund supermarket comparison table will change significantly. Unfortunately, exactly what fund supermarket pricing will look like once RDR is complete isn’t clear, making it hard to choose a new provider at the moment.
However, many of the major fund platforms have now announced their “unbundled” charging schemes – unbundled meaning that they must transparently and explicitly charge the investor for their services, rather than getting paid a platform fee in the background out of trail commission. And this is beginning to give us some idea of what fees may look like in a year or so.
How fund charging works now
Most investors do not buy funds directly from a fund company. They buy through an adviser (if they’re taking advice) or through a broker (if they’re DIY investors). The adviser or broker links them to a platform, which is the infrastructure that allows them to invest in hundreds or thousands of funds from different managers through a single account. Both platforms and brokers are commonly referred to by investors as fund supermarkets, although strictly “fund supermarket” only refers to the platform – for more details of how all this works, see the fund supermarket FAQ.
When you do this, many of the charges you pay are met through an opaque series of ongoing rebates that come out of the annual management charge (AMC) taken from your fund by the fund manager. These rebates are known as trail commission. You still end up paying these costs through higher fund management fees – it’s just you never see the charges, so many investors are unaware of how large they are.
If the AMC is 1.50%, the fund manager only keeps about 0.75% of that. They pay the remaining 0.75% in trail commission to the platform. The platform then keeps 0.25% and passes the remaining 0.5% to the adviser or broker that you use to access the platform. (These figures are typical, but exact rebates vary by fund and platform.)
In order to create more transparency and competition on charges, the FSA is proposing to change this by:
- Banning financial advisers from receiving trail commission with effect from January 2013
- Probably banning platforms from receiving trail commission with effect from January 2014
- Possibly – though not certainly – banning brokers from receiving trail commission at the same time as platforms or a bit later
This means that all three types of firm will need a new pricing model that relies on explicit fees charged to the client rather than opaque rebates from the fund manager.
- Platforms will have to offer “clean share classes” for all funds, where clean means the fund does not pay rebates and consequently has a lower annual management charge (AMC). So in the example above, the clean share class will have an AMC of 0.75% rather than 1.50%. (Alternatively, they may be allowed to continue receiving rebates, but have to pass the entire amount back to the investor – the FSA hasn’t yet decided if this will be allowed.) They will then have to charge explicit fees on the client’s portfolio to make up for the 0.25% they are losing through not getting the platform rebate.
- Advisers will no longer get their 0.5% ongoing trail commission and will need to charge up-front fees or negotiate an annual percentage fee to be taken from the portfolio.
- Assuming that the FSA ban brokers from getting trail commission, they will need to charge dealing commissions, custody charges or account fees, rather than offering zero direct fees and getting paid from trail commission.
Since this site is geared towards DIY investors, we’re not so interested in what this means for advisers. But it will be extremely relevant to choosing the cheapest way of buying and holding funds. So let’s take a look at how fund supermarket charges are likely to change and what the best providers are likely to be.
The top platforms reveal their pricing
For the most part, the detailed pricing schemes that have been announced so far don’t represent what the end investor can access. Platforms such as Cofunds, FundsNetwork and Skandia Investment Solutions are intended for financial advisers and execution-only brokers to use – individuals can’t open an account with them directly (strictly speaking, you can with FundsNetwork, but doing so is actually more expensive than going via a good discount broker).
Of the platforms that deal directly with consumers (known as “d2c” in the industry jargon), only Alliance Trust Savings yet has a pricing scheme that’s consistent with the RDR changes. AJ Bell, the firm behind Sippdeal, has announced RDR pricing for its Sippcentre platform, but that’s only available via advisers – it hasn’t said how Sippdeal fees will change. Hargreaves Lansdown and BestInvest Select, two other popular firms, haven’t announced anything yet.
The table below summarises the unbundled platform fees that have been announced so far for these firms.
AJ Bell Sippcentre
|Annual fixed fee||£40||No fee, but a minimum charge of £8.3 per month||£45||a) £12 per quarter OR b) £120 per year||None|
|Annual percentage fee||0.29% up to £100,000||0.5% up to £25,000||Flat rate 0.25%||None||0.2% up to £1,000,000|
|0.26% from £100,000 to £250,000||0.35% from £25,000 to £100,000||0.15% from £1,000,000 to £1,500,001|
|0.23% from £250,000 to £500,000||0.3% from £100,000 to £500,000||0.1% from £1,500,000 to £2,000,000|
|0.2% from £500,000 to £1,000,000||0.25% from £500,000 to £1,000,000||0.05% above £2,000,000|
|0.15% above £1,000,000||0.15% above £1,000,000|
|Dealing fees||None||None||None||a) £12.5 per purchase and sale OR b) No dealing fees||£3.95 per purchase and sale|
Again, of all of these, only Alliance Trust’s first option represents something the individual investor can directly access (the £100/year with no dealing fees option seems to be only via advisers). Others will require an intermediary discount broker, which will add its own charges – or in AJ Bell’s case, a decision as to how it will price its d2c offering if it can no longer keep earning trail commission there.
What the brokers are doing
If you invest in one of the platforms through a discount broker, the broker receives the trail commission through the platform and passes some or all of it on to you. They cover their own costs either by retaining part of the commission or by charging explicit fees. If there is no trail commission coming through the platforms or an FSA ban on taking commission, only the option of charging explicit fees will be open to them.
Given that many of the platforms have only relatively recently rolled out unbundled pricing, it’s no surprise that brokers have generally made even less progress in announcing their own charges that do not depend on trail commission. What we know so far is:
- Interactive Investor, which uses Cofunds, has announced a quarterly charge of £20, which includes two “free” trades. Subsequent trades are priced at £10 each or £1.50 for regular investments. This is on top of Cofunds’ charges.
- Cavendish Online, which uses FundsNetwork, currently charges no direct fees and gets a 0.05% cut from FundsNetwork’s platform rebate. The firm has said that it expects to continue on a similar basis once RDR comes in and that FundsNetwork’s £45 annual charge under the unbundled scheme will be waived for Cavendish clients.
- Commfreefunds, which uses Cofunds, currently charges 0.19% per year. This is on top of Cofunds’ charges.
- Clubfinance has an RDR compliant service called Frequent Trader that uses James Brearley’s Pro Icon platform and charges a 0.35% per year fee (minimum £25 per quarter), including the Pro Icon platform fee. It has not officially announced a post RDR charging scheme for the Cofunds, FundsNetwork and Skandia platforms, on which it currently holds onto some of the trail commission basis – however, James Brearley’s underlying Pro Icon platform fee is 0.25%, so one obvious possibility seems to be that Clubfinance will similarly add about 0.1% on top of the unbundled fees for other platforms as well.
To make things even more confusing, while the platforms have rolled out unbundled pricing for advisers – because advisers need to be using this with effect from January 2013 – they are still generally offering bundled pricing through brokers. So if an investor buys a fund through Interactive Investor, Cofunds will still receive trail commission and keep some for itself before passing the rest onto Interactive Investor, which then pays it back to the client.
As a result, even now these pricing structures don’t represent exactly how things will work if the FSA sticks to its proposals and completely bans trail commission to platforms and brokers. However, they at least give some idea of what fees are likely to look like if a complete ban comes into effect.
Among the major d2c platforms, the outcome is even less clear:
- Alliance Trust charges £12.50 per purchase or sale (£1.50 for regular monthly investments) and a £12 (£10+VAT) quarterly fee. It rebates all trail commission to clients.
- Hargreaves Lansdown is currently charging £1-2 per fund per month in custody fees for funds that don’t pay trail commission, so that may be an indicator of the direction it will try to take. It continues to receive trail commission on most.
- BestInvest currently charges £12.50+VAT per quarter if you hold investments that don’t pay trail commission. It continues to receive trail commission on most.
- Sippdeal charges £9.95 per purchase or sale (or nil for regular monthly investments into most funds on its core fund list), plus a quarterly fee of £12.50 if you hold funds not on the core fund list. It continues to receive trail commission on most.
Of these, only Alliance Trust is consistent with a transparent, unbundled charging structure. Sippdeal’s current fees are considerably less attractive than the new unbundled rates for advisers through Sippcentre – if it ultimately moves towards the same kind of prices for direct investors, it would be a promising option. Hargreaves Lansdown and BestInvest are among the more expensive supermarkets out there and will probably wait as late as they can before changing their pricing options.
Will investors pay less under RDR?
There has been a great deal of speculation about whether investors will end up paying less or more as a result of RDR. Under the present system, an investor who has a 1.5% AMC taken from their fund and ends up with a rebate of about 0.5% after costs pays a net annual cost of 1%.
This represents roughly what the outcome would be through Cavendish and FundsNetwork at present, which is likely to be the best deal for a small portfolio. Larger investors might do a bit better through Alliance Trust Savings or Interactive Investor/Cofunds, since they offer slightly larger rebates, somewhat offset by fixed fees.
After RDR, clean share classes (or full commission rebates) should take the fund charges down to 0.75%. Based on what’s been announced so far, explicit platform and broker charges are then likely to add 0.25-0.35% or lower, depending on portfolio size – although some firms will undoubtedly be more expensive.
This suggests even small DIY investors are unlikely to lose out – assuming Cavendish/FundsNetwork keeps the current level of fees, there will still be a combination that means a net annual cost of around 1%. And larger investors may even do better.
However, ideally this should be just the starting point. Greater transparency should create pressure to cut platform, broker and fund manager charges from a number of sources:
- The wide variation in charges at different platforms and brokers will be more obvious. A firm such as Hargreaves Lansdown is currently taking at least 0.5-0.6% in trail commission, since it gets both the platform and broker’s share (and possibly significantly more – it is widely believed to have used its clout to get even bigger rebates from fund managers than most platforms). Investors tolerate this when they don’t see it – but whether they will accept it when charges are more explicit and easily compared to other firms on 0.20-0.35% is unclear.
- Expensive funds will be more easily compared to low cost alternatives. Decoupling platform charges from rebates should mean that platforms are also willing to offer investment trusts and exchange traded funds, which don’t pay trail commission, as well as funds from those fund groups that refuse to do so. More expensive funds are carried alongside these may need to cut charges to look competitive.
- Since platforms will no longer get a cut of the AMC, they should have less interest in defending the convention that most AMCs are at a standard level of 1.5%. In fact, since they will be charging the client directly, they may need to justify the use of their platform on the basis of offering low-cost investments. As a result, they may put pressure on fund firms to offer further discounts on AMCs through them.
Hence 0.25% may well not be the bottom for platform and broker fees and 0.75% may only be a starting point for clean fund fees. So while RDR may look more complex at first, it could well mean a much better deal for investors in the long run.
On the downside, the lack of certainty around the final rules and provider pricing make it very difficult to choose a fund supermarket today and be certain that it will still offer what you need a year or so from now. If you can wait until details are clearer before opening a new account, it probably makes sense to do so.
However, based on announcements so far and the past performance of the firms involved, it seems likely that Cavendish/FundsNetwork combination will try to remain a cheap option for smaller portfolios, while Alliance Trust Savings and Interactive Investor/Cofunds may be a better deal for larger ones. So those are probably the obvious providers to look at for the cheapest options for the moment – assuming, of course, that they carry the funds you want.