Fund investors should be in the cheapest share class

The Financial Conduct Authority (FCA) has called on fund managers and financial advisers to move fund investors into the cheapest share class when it is in their ‘best interests’. 

In a statement this morning the City Watchdog said if the end result leaves a fund investor better off in terms of overall cost it expects firms to transfer fund investors from the old commission-paying share classes to ‘clean’ share classes. The move marks a victory for Money Observer, which two years ago called on fund managers to at the very least inform customers in higher-paying share classes that they could secure themselves a cheaper deal elsewhere.   

Typically, the overall cost of a clean share class is a third cheaper, as we explain below, so it would be in most investors’ best interests. Around one in three fund investors hold the most expensive share class, according to research carried out by Fitz Partners.  

The move is part of a number of changes introduced by the FCA in order to ensure fund managers offer investors value for money. As part of the changes, fund groups will be required to publish an annual report that sets out how they have provided value for money. In another change that has been introduced, fund firms must appoint a minimum of two independent directors to their boards.  

Elsewhere, the FCA has called on fund managers to communicate fund objectives more clearly and also spell out whether the performance of a fund is limited in terms of how far its holdings can differ from the weightings of a benchmark index. 

Share class muddle    

Most investors have been moved to clean share classes, following rule changes first introduced in 2013, as part of the Retail Distribution Review (RDR), which banned the commission payments that were received by financial advisers when recommending their products. As part of the rule change investors with fund platform accounts were gradually moved by their fund platforms over to the newly created 'clean share classes', which are commission-free. 

Investors who use an online broker, either in their own right or through a financial adviser, will therefore now find themselves investing in commission-free funds via ‘clean’ share classes. They will pay a separate fee to their broker: either a fixed fee or one based on a percentage of their investment. Similarly, those who use a financial adviser will be charged explicitly. 

However, the commission ban does not apply where a financial adviser or self-directed investor buys assets directly through a fund management company rather than via a platform. Those who ‘go straight to the manufacturer’ in this way still incur commission charges.

Similarly, investors who have in the past invested directly with a fund management company themselves, without an adviser, are not being moved into clean funds, as the fund management group is not required to transfer them. 

As things stand, those who invested directly with the fund group via an adviser still have commission (typically 0.5 per cent) paid to the adviser, even if they are no longer receiving any service. Directly invested self-directed investors, meanwhile, simply pay commission fees to the fund manager for non-existent advice.

In most cases switching from old-style commission share classes to new clean versions would be in the investors’ best interest. Typically, the old commission-paying share classes have an ongoing charges figure of 1.7 per cent. 

The clean share class normally costs half as much, on average 0.85 per cent. Even when the variable broker fee is factored in, the typical all-in fund cost comes in at between 1.1 and 1.3 per cent. Therefore, going down the direct route is therefore typically around a third more expensive.

Client’s best interest 

The FCA points out that under its ‘client’s best interest rule’ firms must act ‘honestly, fairly and professionally in accordance with the best interests of its client’. It adds that asides from in cases when there is an ‘overall increase for clients’ to move to clean share classes, a conversion would be in a client’s best interest. 

Mike Barrett, consulting director at the Lang Cat, welcomed the move. ‘Previously fund managers have argued they need to trace the end investor to move them to the clean share classes, but the FCA has now stepped in and put an end to this. They will now be moved and for most it will be in their best interests to do so as the overall cost will be lower. 

‘Ordinary people do not understand fund charges so most will not be aware they can pay less for the same fund, whereas fund management groups have known for years and have arguably taken advantage. I welcome the move, as it is part of a package of reforms announced today that will give consumers better value for money.’ 

Christopher Woolard, executive director of strategy and competition at the FCA, says: ‘The investment choices open to people, and the decisions they make on how to invest, can have a profound impact on their financial health. They can also have consequences for their families, as well as society as a whole. 

‘That’s why it is important the asset management industry, which looks after the savings of millions of investors, is working as well as possible. But our market study found evidence of weak price competition in a number of areas. 

‘Today’s announcements are an important part of a package of measures that, combined, aim to achieve a fair, transparent, open and accountable market.’ 

Firms have 18 months to implement the rules on assessment of value and appoint independent directors. 

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