How to avoid overpaying for your funds

If a fund generates an income, each of its share classes usually comes in two categories. These are indicated by 'Inc' for the income share class which pays out any income received by the fund, and 'Acc' for the accumulation share class which automatically reinvests the income in the fund. A few funds have more than one income category because they offer their investors the option of taking the payouts on a quarterly and monthly basis.

There are usually different share classes available to institutional investors and retail (private) investors. Institutional share classes tend to have lower charges than retail share classes, because institutional investors buy them in bulk so get a discount. These share classes also typically have higher minimum investment levels, for example of at least £250,000. But these are likely to be the ones that private investors buy too, because investment platforms pool together private investors' money enabling them to meet the minimum purchase requirements of the cheaper institutional share classes. The platform then sells the cheaper share classes to private investors with a much lower minimum investment of maybe £50 or £100.

A fund might also have different share classes based on whether it is investing in different currencies such as US dollars, euros or Japanese yen. Whether this is beneficial will depend on the relationship between sterling and the share class currency. For example, a sterling investor who selects a US dollar fund share class will be exposed to any rise or fall in the value of sterling versus the dollar. For this reason, fund analysts generally suggest that UK investors stick with sterling share classes, although if the underlying assets are denominated in a different currency then their returns will still be subject to currency fluctuations. Investors who want access to international investment opportunities without the effects of the exchange rate could consider investing in funds that offer a hedged share class. These use derivatives to neutralise the impact of any currency movement on returns so you only get the investment returns.  

Bundled, clean and super-clean

A key factor in the cost of a fund's share classes can be whether they were launched before or after 2013, when regulation that prevented asset managers paying commission to financial advisers came into force. Before 2013, the cost of fund share classes offered to private investors included the asset manager's annual management charge, and commission paid to intermediaries such as financial advisers and investment platforms. If you hold a retail share class launched before that date its charge still includes commission – the reason why it is probably more expensive than institutional share classes, or 'clean' ones launched after 2013.

Fund share classes that do not include commission are often referred to as clean share classes, and those that pay commission are often referred to as 'bundled' or 'legacy' share classes. Legacy share classes typically have an ongoing charge of around 1.5 per cent, but clean share classes typically have an ongoing charge of around 0.75 per cent.

Research firm Fitz Partners recently found that 34 per cent of retail (private investor) assets invested in UK funds are still in legacy share classes that pay commission to intermediaries, down from over 70 per cent in 2013. Investors who remain in legacy share classes may be paying substantially more for their funds than if they held clean share classes: Fitz Partners found that the difference between the average ongoing charge for legacy retail share classes and the average ongoing charge for clean retail share classes was 0.55 per cent.

Ian Millward, director at Candid Financial Advice, says investors in legacy share classes tend to have bought them directly from the asset manager which provides them and have not looked at them for several years. This may be because they bought the funds within a personal equity plan (Pep) – a type of tax efficient wrapper that is no longer available – and have forgotten about them. 

But if you hold your investments on an investment platform you should not be paying expensive fees for holding legacy share classes. Since 2014 platforms were also stopped from receiving commission payments from fund providers for new investments. And with investments made into funds before 2014, platforms are required to rebate the commission incorporated in the fee back to investors.

Platforms apply the rules in different ways. Some such as Bestinvest only offer clean share classes, and rolled their customers in older share classes into these. Platforms including Fidelity Personal Investing list the full range of clean and legacy fund share classes on their websites, but only allow investors to add new money into the clean share classes. And Hargreaves Lansdown allows investors to put new money into legacy share classes but rebates the difference between the legacy share class's ongoing charge and the clean share class's ongoing charge.

Some platforms also offer 'super-clean' share classes. These are fund share classes offered at discounted rates that a platform has negotiated with a fund provider, because it has a large number of clients and is likely to buy in bulk. For example, Hargreaves Lansdown offers the Jupiter Income Trust (GB00BQXWPW10) Z share class for an ongoing charge of 0.34 per cent – a 0.6 per cent discount to the 0.94 per cent ongoing charge on the I share class, and well below the 1.69 per cent charge on the legacy share class. 

Hargreaves Lansdown also recently won a legal challenge against HM Revenue & Customs (HMRC), meaning that any discounts on fund fees paid to investors by platforms should not incur income tax, even if the funds are held outside a tax-efficient wrapper. But HMRC has the right to appeal the decision over the next few months.

But Jonathan Miller, director of manager research ratings at Morningstar, says: "Remember that platforms have varying annual costs to hold the assets [on them], so a fund that's cheaper [on a given platform], might not be cheaper all in, once the platform fee is taken into account."

You can check the full range of a fund's different share classes and their costs on data providers' websites such as FE Trustnet and Morningstar. 

How to ditch an expensive fund share class

The Financial Conduct Authority has recently brought in new rules making it easier for asset managers to move fund investors out of expensive legacy share classes into cheaper share classes. Previously asset managers needed an investor’s consent to do this, but now they only need to give investors 60 days' notice before transferring them to a cheaper share class. This is something asset managers are likely to do says Hugues Gillibert, chief executive officer of Fitz Partners, as having multiple share classes creates costs for them. But if they close the legacy share classes and move these investors into clean share classes, it will reduce these costs. 

However, as it is not guaranteed they will do this, if you hold funds' legacy share classes take action yourself. If you want to continue investing directly with the asset manager, contact them and ask them to transfer your holdings to the cheapest share classes. "Make sure you instruct them to do this as a share class conversion rather than as a fund switch," says Mike Barrett, consulting director at platform research company the lang cat. "A fund switch involves selling the fund and buying it again." A switch could incur trading costs, and if the funds are held outside a tax-efficient wrapper it could crystallise a capital gains tax (CGT) liability. But a fund share class conversion typically will not trigger either of these costs as it replaces your fund units with other units.

It is also worth considering whether your assets would be better off invested via a platform as these allow you to hold all your investments in one place. If you have funds worth £100,000 or more, a platform, particularly one with fixed costs rather than percentages fees, is a good option says Mr Millward.

How you transfer your assets onto a platform depends on whether they are held within a tax-efficient wrapper such as an individual savings account (Isa). If you opened a Pep directly with an asset manager and didn't close it, it would have been reclassified as a stocks-and-shares Isa in 2008. So to move the assets within it onto a platform you should request an Isa transfer from the asset manager to your chosen platform. This can be done either by selling your legacy share classes and repurchasing cheaper ones from the investment platform or 'in-specie' – when you remain invested in your funds and they are transferred across. Typically asset managers allow investors to do this type of Isa transfer for no charge.

But you will only be able to do an in-specie transfer if the platform you are moving to is willing to hold legacy share classes, and rebate you the cost difference between these and the clean share classes it offers.

If you hold a fund directly with an asset manager outside a tax-efficient wrapper, you will need to sell the fund and then repurchase it on a platform. Selling funds you've held for several years could crystallise a CGT liability if the investments have done well and you have made a profit on your original investment.

"You might want to save on the charges of your share class, but you don't want to end up incurring CGT of 10 or 20 per cent in doing so," warns Mr Millward. He suggests that investors in this situation sell their assets over a few years, making use of their full annual CGT allowance, which for this tax year is £11,700. And when repurchasing the funds on a platform, look to do this within an Isa to make sure your future gains grow in a tax-efficient way, a process known as bed and Isa.

If you are married you could also make use of your spouse's annual CGT allowance by transferring some of the assets to them, as transfers of assets between spouses do not incur CGT. The spouse could then sell them using their £11,700 CGT allowance, and reinvest in cheaper share classes, making use of their annual Isa allowance. So, for example, over two years a married couple could crystallise £46,800 of gains without triggering any tax bill.

Fund share classes for the three funds with highest total returns over five years

UK Equity Income sector

Source: FE Trustnet as at 12/04/18

UK All Companies sector

Source: FE Trustnet as at 12/04/18

Global sector

Source: FE Trustnet as at 12/04/18