Guide to Clean Pricing. By Kathryn Cooper

Transcription

1 Guide to Clean Pricing By Kathryn Cooper

2 Kathryn Cooper, economics correspondent and former Money editor, Sunday Times Contents Guide to Clean Pricing 3 How did commission work? 4 What if I don t want advice? 4 What will change? 5 What will my platform charge? 5 What will I get for my fee? 6 Will investment charges overall come down? 6 What about my existing funds? 7 Conclusion 7

3 GUIDE TO CLEAN PRICING This year has seen one of the biggest overhauls of the investment industry for several decades. From 31 December, the City regulator banned fund managers from paying commission to financial advisers who sell their products. Instead, the cost of advice must be negotiated upfront, between the adviser and the investor. Hidden commission payments have been allowed to distort the investment market for far too long. Advice has never been free, but because the cost was bundled together in the product with other investment charges, investors didn t always understand what they were paying. Commission has been at the heart of many of the biggest scandals of recent times, including pension and endowment mis-selling. All too often, it incentivised advisers to sell products that paid the most commission, rather than those that were in the best interests of clients. Now that costs are more transparent, The Financial Conduct Authority (FCA) hopes the risk of more mis-selling scandals will be vastly reduced. Over time the cost of commission can have a huge impact on the value of your funds. For example, an investment of 20,000 that grew by 6% a year would be worth 64,143 after 20 years with no charges but, 46,787 if a 3% initial charge and 1.5% annual charge are taken into account, according to figures from BDO LLP, the accountant. Of that theoretical 17,356 taken in charges, only 7,716 would have gone to the fund manager to cover the cost of running the fund. The remaining 9,640 would have gone in commission to either the adviser or the platform used to buy or sell the funds, or been split between the two. That is a huge sum especially given many investors do not even realise they are paying commission. Another of the problems with the old system was that commission could be taken out of an investor s funds even when they were not receiving advice, but were buying either direct from the fund manager, or through a discount broker or online platform. The new rules are planned to apply to platforms from April 2014 and the good news is many execution-only services are already revamping their charging structures in advance of the new rules. Despite this being one of the biggest transformations of the way we buy and sell investments for many years, most people remain unsure about the changes. In a survey of clients by Garrison, the fund supermarket owned by Charles Stanley, 60% were aware the changes had come into force this year, but more than two-thirds did not know whether they were positive or negative for them. This guide will explain the new investment landscape and how you can make sure you are not paying over the odds. 3

4 How did commission work? Under the old system of hidden commissions, the balance of power was with the fund manager and the adviser, with many investors in the dark over how advice was paid for. Many people mistakenly thought advice was free, even though charges for advice could cost thousands of pounds over a lifetime of investment. Take a typical investment fund with an initial charge of 3% and an annual management charge of 1.5%. The fund manager might pay all of the initial 3% back to the adviser as upfront commission. Of the 1.5% annual charge, only about 0.75% would go to the fund manager to cover the cost of running the fund. Another 0.5%, known as trail commission, would be paid by the fund manager to the adviser or distributor of the fund to cover the cost of advice or distribution. The remaining 0.25% might go to the execution-only platform used by the investor (or their adviser) to buy or sell their funds. The research by BDO found that out of total charges of 17,356 on a 20,000 investment growing over 20 years as in the example on the previous page, 1,924 would go on initial commission, 5,144 would be lost in trail commission and 2,572 would be paid in platform charges. Only 7,716 covers investment management for the fund you have bought. Despite the thousands of pounds paid out in trail commission, which is supposed to cover the cost of ongoing service by your adviser, surveys have suggested that one in five investors have never had a portfolio review from their financial adviser. This shows precisely why the system was in dire need of change. Many people mistakenly thought advice was free, even though charges for advice could cost thousands of pounds over a lifetime of investment What if I don t want advice? In practice, many investors are confident enough to make their own investment decisions. These do it yourself investors use online brokers or platforms to buy and sell their investments. As these platforms do not offer advice, they are able to offer discounts on fund charges. However, large amounts of commission may still be coming out of your funds, yet they remain invisible to private investors. The discount broker might waive most or all of the initial commission, so that many funds are available at zero initial charge. They also receive the 0.5% trail commission, plus some will receive the 0.25% platform fee from the fund manager so up to a total of 0.75% a year on a typical fund. In practice, many of the larger discount brokers wield such power that they may negotiate bigger payments from the fund managers. Some of this may be paid back to the investor in the form of a cash rebate/loyalty bonus, but the broker could still be keeping as much as 0.5% to 0.65% a year despite not giving advice. Under the new rules coming in from April 2014, investors will be able to weigh up whether this is a fair price to pay for an execution-only service. Some wealth managers charge the same rate -around 0.5% to around 0.5% to 0.75% a year - for a full discretionary-management service on larger portfolios. As platform charges become more transparent, it should become easier to judge if you are getting good value for money. 4

5 From this year, fund managers can no longer pay commission to advisers What will change? From 31 December 2012, fund managers can no longer pay commission to advisers either upfront or trail commission. The cost of advice will have to be negotiated upfront between the adviser and the individual. Financial advisers will also be qualified to a higher professional standard and will have to call themselves either independent or restricted. The former should recommend products from the whole market, whereas the latter might offer products only from one company, or a limited range of products. From 6 April 2014, fund managers will also be banned from paying commission to platforms for new business. Cash rebates which often take the form of loyalty bonuses will also be banned, although platforms may still be able to pay rebates in the form of fund units. However, there is pressure for all rebates to be discontinued to give a fully transparent system. HM Revenue & Customs recently dealt another blow to rebates when it announced that they would be subject to income tax from April The ruling will be applied to both cash and unit rebates. On all non-tax wrapped assets platforms will now have to deduct basic-rate tax from the payments, with higher-rate payers liable to pay the rest through the self-assessment system. The administrative complexity is likely to mean many platform services drop rebates altogether, especially as the regulator has now announced a complete ban on all cash commission payments from funds to platforms from April 2016, even if you hold these funds already. Many fund managers have already launched clean priced units for their existing funds in other words, the fee covers just the cost of fund management, with all the costs of administration, advice and distribution stripped out so the investor can compare these separately and knows exactly what they are paying for. What will my platform charge? Many discount brokers and platforms are waiting until next year to announce how they will comply with the new rules. Others, in the spirit of transparency, are moving early and overhauling their charges. Some platforms have decided to charge one explicit, clean fee to cover their administration costs, which might be a percentage of the funds you buy through them around 0.25%, although this may be reduced for bigger sums. The Garrison survey found that 43% of investors would prefer an explicit fee compared with only 34% who wanted costs taken out of their investments, suggesting the new rules will find favour with investors. Other platforms may charge per transaction, but the over-riding principle is that the costs should be transparent and it should be much easier to judge if you are getting a good service in return for your fees. 5

6 What will I get for my fee? Many industry watchers are expecting an explosion in the number of self-directed investors using online execution-only services as they baulk at the fees being demanded by financial advisers especially if advisers gave them only a minimal service in the past. Financial advisers are also likely to focus on their wealthier clients because those with smaller investment portfolios may find that upfront fees are prohibitive. Among advisers who decide to charge an hourly rate, the average is likely to be 160 an hour, according to BDO. This may also push smaller investors towards execution-only services. However, there are likely to be a vast array of execution-only services on the market with varying levels of fees. For the most sophisticated investors who do their own research and don t want any guidance, there are likely to be plain-vanilla platform services that simply facilitate the buying and selling of investments and provide custody of those investments. Others may provide specialist telephone and investor support through online tools or proprietary research. These online services could help investors understand the level of risk they are taking with their current asset allocation. The vast assortment of services on offer is likely to mean that charges vary widely at least initially as platforms test the market and work out a fair price for their services. Investors have never paid for these services directly in the past, so nobody is quite sure what consumers will be prepared to pay. The main thing is to make sure you understand what you need from your execution-only service, and then compare like with like when working out which offers best value for money. Only the most sophisticated investors, such as frequent share traders, are likely to be comfortable with a service that offers no ongoing help or information. Will investment charges overall come down? Nearly two thirds of investors fear they could pay more following this year s changes, according to the Garrison survey. There is certainly a risk charges could go up in the short term as the market settles. However, as investors get a clearer understanding of the true cost of commission, they should be able to demand a better deal from their adviser or their platform. Only those firms which offer genuine value for money will survive and, over time, charges should fall. Some fund managers may set the price of their clean units above the standard 0.75%, because in the past they may have been getting less. Discount brokers and platforms had so much power that some fund managers may have been left with as little as 0.65% or less to cover the cost of running their funds. However, because there are now no other charges bundled in with their management fee, investors should be better able to judge whether they are getting value for money. Likewise, some advisers may try to raise their fees initially. Research by BDO found that advisers typically took commission of 0.6% a year under the old system, but expected their charges to go up to 0.8% a year under the new rules. However, transparency should lead to investors being able to judge what value they are receiving from the service being provided. 6

7 What about my existing funds? The new FCA rules allow commission to be paid and therefore rebates on existing funds can continue. This will cease to be allowed from April However as all new business needs to be in clean commission free funds from April 2014 it is likely that discount brokers and platforms will move to the new fee charging model well before this mandatory date. This is very positive news for private investors, as the offer of cashbacks and loyalty bonuses can often mask the existence of large commissions still being retained. Conclusion The City watchdog first starting investigating commission more than a decade ago amid fears it was distorting the market and putting power in the hands of advisers rather than investors. The review of commission has been its biggest-ever piece of work, and the results are a victory for transparency. Investors will no longer be in the dark over what they are paying and, armed with this new information, they should be able to demand value for money. That is not to say they have always received poor value for money in the past; it was just very difficult to judge because charging structures were so opaque. Now advisers remuneration will be much better aligned with the interests of the investor and it will be much easier to judge if you are paying for genuine ongoing service or just an initial product recommendation. Everyone in the industry be it fund manager, adviser, broker or platform has a duty to charge a clean price for their services so that investors understand what they are paying. Hopefully these changes will mitigate the risk of further mis-selling scandals. This is a marketing communication. The information in this booklet is based upon sources we believe to be reliable, but its accuracy cannot be guaranteed. The information does not constitute advice or a personal recommendation or take into account the particular investment objectives, financial situations or needs of individuals. The value of investments and the income from them may fall as well as rise and you may not receive back the amount you originally invested. Charles Stanley Direct 2 Multrees Walk, St Andrew Square, Edinburgh EH1 3DQ T +44 (0) F +44 (0) E info@cs-d.co.uk W Charles Stanley Direct is a trading name of Charles Stanley & Co. Limited which is authorised and regulated by the Financial Conduct Authority. A member of the London Stock Exchange, the London International Financial Futures and Options Exchange and the International Capital Market Association. Registered in England No Registered Office: 25 Luke Street, London EC2A 4AR. Tel: VAT number: GB