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Move your investments to get a cheaper deal

Hundreds of thousands of investors who opted to buy funds directly from a fund manager - in many cases 20 years ago or more - are being left languishing in old-style commission-paying share classes.

Typically these direct investors are paying an ongoing charges figure (OCF) of 1.7 per cent on the funds they own. The clean (commission-free) share class normally costs half as much, on average 0.85 per cent.

For investors who choose to use a broker or platform, a separate broker fee is applied, but as a rule of thumb that fee plus the OCF will typically add up to between 1.1 and 1.3 per cent. Going down the direct route is therefore typically around a third more expensive.

But direct investors who ask their fund manager to switch them into clean share classes are unlikely to have their wishes granted, because there is no regulatory obligation for fund managers to move investors across to the cheaper clean share versions.

LEGACY BUSINESS

Platforms, on the other hand, had until April this year to move investors across to the clean share classes. They are no longer allowed to pocket ongoing trail commission from the manager, but instead must charge an explicit fee for their services.

For advisers it is more complicated. Commission payments are banned on new investment products bought since the start of 2013. For 'legacy business', financial advisers who use platforms have also had to move their clients over to the clean share classes.

This, however, only applies to Isas. And for those advisers who in the past (pre-2013) invested their client's money directly with a fund manager, the commission payments are still allowed.

Mike Barrett from platform consultancy Lang Cat says that this may suit investors who still want to pay their adviser via commission.

'If you move to the clean share class this commission will end, and the adviser will probably suggest a move to a platform, so the question is whether the cost of paying for advice and the platform charge is offset by the reduced cost of the clean share classes. In almost all cases the cost will be similar,' says Barrett.

Self-directed investors, on the other hand, are simply paying more to the fund manager for non-existent advice.

CAMPAIGN FOR CHANGE

Managers claim they face administrative costs and 'higher levels of service' for direct investments and are therefore justified in retaining the higher-paying share classes.

However, Money Observer is calling on fund managers to write to customers, explaining that they could move their money elsewhere and own the same fund more cheaply.

We would prefer managers to go further. We appreciate there is an administrative cost, but we think any charges levied should be reduced and made transparent.

Our campaign has been backed by respected industry figures, including Daniel Godfrey, the former chief executive of the Investment Association, Boring Money's Holly Mackay, Candid Money's Justin Modray, Damien Fahy, founder of website moneytothemasses.com, and the Lang Cat.

HOW TO DO THE SWITCH YOURSELF

For direct investors who hold investments with a fund management company, whether bought in person or via a financial adviser, one way to switch to clean share classes is to sell the holdings and then repurchase them via a platform.

But the problem with this approach is that for funds not held in an Isa, any move could trigger a capital gains tax (CGT) liability. The first £11,100 of annual gains are currently exempt from CGT.

FEES AND CHARGES

The problem with fees and charges is that they haven't been particularly transparent, although the situation is beginning to improve. What charges apply and how much they are going to set you back can vary enormously.

First is the annual management charge (AMC) and then other costs, which, when added to the AMC, will be expressed as the ongoing charges figure (OCF), which used to be known as the total expense ratio (TER).

However, this isn't the full picture as there will be other running costs and dealing charges on top of the OCF, which will impact more on funds that have a high portfolio turnover. That is particularly true for UK equity funds, where stamp duty of 0.5 per cent is levied on share purchases.

On top of this, some funds (and investment trusts) also levy a fee if the fund surpasses a predetermined performance level. This 'performance fee' could be based on an absolute measure, such as Bank of England base rate, or outperformance of a selected benchmark, such as 5 per cent more than the annual performance of the FTSE 100 index. In the latter example this could mean investors end up paying a performance fee even if the fund loses money, but doesn't lose as much as the reference benchmark.

The most obvious way to reduce your costs is by opting for passive rather than active funds. These products are often referred to as 'trackers' because they attempt to replicate an index, such as the FTSE 100, rather than beat it. As you are not paying a fund manager to make decisions, the annual costs will be lower at around 0.25-0.5 per cent.

Another way to reduce the cost of investing in open-ended funds is to make sure you choose the correct share class. In the past, fund management groups bundled up all sorts of charges into the typical 1.5 per cent AMC.

In fact, most actively managed equity funds typically levy a 0.75-1 per cent AMC. The rest is divided between fund distributors: financial advisers get a 'trail' commission and fund platforms can also receive this commission and an extra platform fee for offering a fund to investors.

So it's important that if you are a self-directed investor, you make sure that you can take advantage of rebates on these extra fees that some fund distributors offer. Some fund platforms - also known as fund supermarkets - offer a full rebate and others just a partial rebate.

This is particularly pertinent for investments made before 6 April 2014. Because these do not count as 'new' investments, financial advisers and fund platforms can continue to collect trail commission on funds that you hold. This can apply not only to a lump sum investment you made in the past, but also to contributions via regular savings.

Investors who are not receiving a rebate on the old-style share classes could be losing 0.5 per cent a year on these legacy investments until 5 April 2016. At that point all legacy fund investments must be switched into a clean share class.

Investors have another option, which is to switch into the so-called 'clean' share classes. Most fund management groups have now launched these in response to the Retail Distribution Review which was implemented on 31 December 2012. Its main aim was to seek to eliminate so-called 'commission bias' on investment recommendations. Some, but not all, fund platforms and supermarkets are already switching clients into clean share classes.

In their purest form, clean shares classes include only the fund manager's annual fee, although some also continue to include a platform fee.

Choosing a clean fee share class means less potential drag on fund performance, but it also means less paperwork - HMRC taxes cash rebates on funds that are not held in a stocks & shares Isa or personal pension.

From 6 April 2014 any new investments into open-ended funds must be via a share class that has trail commission stripped out. However, as mentioned previously, regular investments can count as ‘ongoing business’ until April 2016.
Active versus passive in the ‘clean’ fund world

In the past, you might have been paying 1.5 per cent to own an actively managed fund and 0.25-0.5 per cent to own a passive fund. Even if you were receiving a small commission rebate on the active fund, the difference was up to five or six fold.

Now, if your fund provider charges you an additional percentage-based fee for holding assets on a platform, you’ll pay a typical 0.75 per cent for the fund plus an average 0.35 per cent platform fee. That amounts to 1.1 per cent for the active fund compared with 0.6 per cent (0.25 per cent plus 0.35 per cent) for the equivalent passive fund.

That equates to less than half the difference previously. For many investors, choosing a platform that levies a flat fee could be more cost-efficient.


CONSIDER ETFS

You may also want to consider exchange traded funds (ETFs), which have grown in popularity over the past decade. These provide access at relatively low cost to a wide range of different investments: including exposure to countries as diverse as the US or Vietnam; asset classes from gold to emerging market bonds; and growth or income-oriented strategies.

Their passive approach makes them similar to tracker funds but the difference is that they are traded on an exchange, similar to a share. This gives investors relatively straightforward access to a wide variety of investments on a real-time basis.

Although ETF transactions are subject to the same fees as share transactions, they generally have lower management fees. However they do not attract 0.5 per cent stamp duty on purchase, as with other listed shares. They can also be traded at any time, offering investors much greater control in terms of timing.
CONSIDER INVESTMENT TRUSTS

It is also worth looking at investment trusts, because their AMCs are often lower than on equivalent open-ended funds. However purchases of investment trusts are subject to stamp duty of 0.5 per cent of the amount invested.

Investment trusts are quoted companies in which you buy shares, the price of which will be determined by supply and demand rather than the value of the underlying assets, meaning their value can fluctuate more than unit trusts, although fees are usually lower.

Trusts can also retain up to 15 per cent of the income they receive from dividends each year and put it into their reserves. This process, known as 'smoothing', helps them pay dividends in more difficult years and is worth bearing in mind for income-seekers.

Trusts can also gear-up, or borrow money, in the hope of generating a higher return than the cost of the loan. If successful, it will magnify gains, but is likely to leads to bigger losses in falling markets.

Some open-ended funds have a mirror investment trust, which will almost always be cheaper.


FINALLY...

Don't forget to shield as much money as possible away from the taxman - the first port of call should be utilising the tax-efficient qualities of your annual Isa and pension allowances.

Unless a financial adviser is administering funds on your behalf, you should also try to cut the overall cost of investing by ensuring you are getting the best deal possible via discount brokers and fund supermarkets.

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