In January next year, the way consumers get financial advice and buy investment products will change dramatically. As a result of the Retail Distribution Review (RDR), commission payments to financial advisers (IFAs) for distributing products such as unit trusts and open-ended investment companies (Oeics) will no longer be allowed. At the moment, if you go to a commission-taking adviser you get what seems like free financial advice, but this is not the case. Your advice is effectively being paid for via the charges on your fund, which include the adviser's commission. The product provider gives your adviser a percentage of your investment, typically 1-8 per cent, or sometimes more on a lump sum investment. So for an investment of £10,000, your adviser could get a commission of £800.
This, of course, does not apply to investments such as investment trusts and exchange traded funds (ETFs) which do not pay commission.
But, from January, independent and restricted advisers (who will only consider certain products or product providers) will not be able to take commission and will have to charge you a separate fee for their advice, or agree with you that they can take the fee from the sum you invest. Some advisers already operate this model.
"You will know exactly what you are paying and that the advice you receive is not influenced by how much your adviser could earn from the investment," says the Financial Services Authority (FSA).
As a result, many asset management companies are launching commission-free share classes on their unit trusts and open-ended investment companies (Oeics). These have a lower cost as they do not include adviser commission. In theory, this should also be good news for self-directed investors who do not take advice. However, this is not necessarily going to be the case because a number of fund management companies are either not selling the commission-free share classes directly to investors, or are placing such a high minimum investment on them - for example, £1m as opposed to the usual £500 to £1,000 - that, in effect, they are not available to most investors.
Invesco Perpetual, which runs the popular Income and High Income funds managed by Neil Woodford, told us: "These share classes are specifically designed for clients who have an ongoing fee arrangement in place. Invesco Perpetual is clearly focused on supporting intermediaries and values the importance of best advice, therefore Invesco Perpetual has taken the decision to design these share classes this way."
The extent to which these new share classes are not being made available to all investors is not fully clear as not all asset managers have unveiled their plans yet. We have spoken to some of the managers that have launched RDR asset classes. On the next page, we list those that will be selling their commission-free share classes to investors. This is by no means an exhaustive list as many are yet to finalise what their post-RDR arrangements will be, so more options will emerge over the coming months.
Commission-free fund shares
■ Private investors wishing to invest in an Argonaut fund directly can go to distributor IFDS (www.ifdsgroup.com/html_uk2/) to get commission-free share classes. The minimum investment for a lump sum is £500 and the minimum for monthly payments is £50.
■ Baillie Gifford is making its 'B' commission-free share class available from 1 December with a reduced minimum investment of £10,000 as opposed to £250,000. Investors will also be able to access the B share class through platforms such as Alliance Trust Savings, although Baillie Gifford does not yet have a date for when it will be available on these.
■ HSBC has launched commission-free share classes on its tracker funds and they are available for an annual management charge of 25 basis points.
■ JO Hambro Capital Management's (JOHCM) commission-free share classes will be available directly to private investors from January 2013, and the minimum investment will be £1,000.
■ MAM Funds' commission-free share classes are available directly to private investors via the online application form on the MAM website or through Capita, with a minimum investment of £1,000. Although they have a lower charge of 1 per cent, they also have an initial charge of 3 or 5 per cent.
■ Investors will be able to buy the 'B' commission-free share class from UBS from 31 December 2012 with no initial charge and annual management charges of between 0.40 and 1.1 per cent. The minimum investment will be a £1,000 lump sum or £50 per month.
But cost is not the only factor when choosing a fund. "Buying the lowest-cost fund is pointless if the fund performs poorly," says Jason Hollands, managing director at Bestinvest. "But fees are an important factor to consider when selecting a fund because ultimately they are a drag on future returns. We can't predict future performance, but you can model future costs. The higher the costs a fund has, the more convinced you need to be that the manager is going to deliver the additional returns to justify those costs. Most don't, so you need to be super selective. Even then, you should see if you can mitigate some of those fees."
Platform solution
One option already available to private investors is to buy commission-paying funds via a platform or a discount stockbroker, which rebates some or all of the commission paid to it and often waives the initial charge, which can be up to 5 per cent. Platforms and execution-only brokers will not be included in the FSA's commission ban in January 2013, so can continue to take commission and rebate some or all of it to customers, although this may change (see 'Platform payment ban').
So, if a fund's commission-free share class is not available to self-directed investors who don't want advice, buying it from a platform is likely to remain the most cost-effective option. And, with a platform or broker that waives initial fees and rebates some or all of the commission, in some cases it may be more cost-effective to continue with the old retail share classes than the new commission-free ones, although this will depend on the fund and the platform, so you will need to compare them to see which is best in each case.
"From a total cost perspective, buying the commission-paying share classes is likely to be better for clients because clean share classes plus a platform fee or advice fee are likely to incur an element of value added tax (VAT)," says Mr Hollands. "Commission-paying share classes, where we rebate typically half of the commission as a loyalty bonus, do not incur any VAT. By next year there will be lots of talk about cheap funds, but it may still make sense to buy the old-style ones and get a rebate."
"If investors have the option to switch from one share class to another, it is important to understand how the conversions are transacted and whether there are any costs, tax or out-of-market implications," adds Danny Cox, head of advice at Hargreaves Lansdown.
You will also need to check if the commission-free share classes are available on platforms that sell to private investors. Because of the uncertainty about the exact rule changes relating to platforms in 2014, some are waiting to see what this will be before deciding on their policy. Below are some examples of platforms and brokers, together with information on their rebate policies.
Alliance Trust
Many of the funds offered by Alliance Trust have a fully discounted initial charge, and it passes back the provider rebate to the customer in full. The annual rebate on a typical equity fund with an annual management charge of 1.5 per cent is between 0.5 and 0.75 per cent. Alliance Trust Savings is also putting commission-free share classes onto its platform. Since it rebates all commission, there is no financial incentive in commission-paying share classes.
Bestinvest
Bestinvest currently offers commission-paying share classes on its platform, but typically rebates half of this and sometimes more to clients through loyalty bonuses, which can amount to 0.5 per cent a year. It also rebates the initial charge on most funds.
Chelsea Financial Services
Chelsea Financial Services waives the initial fee on most of the funds it offers and does not charge for switching between funds.
Clubfinance
Discount broker Clubfinance rebates 100 per cent of any initial commission and 75 per cent of any renewal commission on investments made or held through a fund supermarket, and uses Cofunds and Fidelity FundsNetwork. Clubfinance's Frequent Trader service has no initial fund charges on over 1,800 funds and full trail commission rebates of up to 0.875 per cent.
Fidelity
There is no initial charge on all Fidelity and Select List funds invested via an individual savings account (Isa) or Junior Isa, and no initial charge on any funds invested in via a self-invested personal pension (Sipp). Investors using Fidelity Wealth service benefit from an annual and initial charge discount on certain funds of up to 0.25 per cent. The Fidelity Wealth service is for investors with £100,000 on the Fidelity platform and is free of charge.
Hargreaves Lansdown
Hargreaves Lansdown rebates the whole initial charge and discounts the annual charge on many of the funds that it offers. Funds held within its Sipp from next year will receive a loyalty bonus of up to 0.5 per cent a year, something already in place with its Isa.
