What’s your strategy?

With no consistent naming convention for share classes and having some commonly used terms meaning different things to different companies, the question is, has this area of the industry become clearer for advisers and their clients?

Having different share classes available to invest in is nothing new, nor having different structures of the underlying funds. Several years ago, insurance company-based funds such as mirror funds were more commonly used in the market than they are today with platforms drawing a line under their dominance.

Before looking closely at trying to answer the question posed, let us remind ourselves of the differences between some of the fund/share classes that have been used over the years, before bringing ourselves right up to date.

Mirror funds dominated the market for years. They remain available today, in particular for single premium investment bonds, and provide advisers and their clients access to a wider range styled on the underlying mutual fund, albeit with different cost and pricing structures.

These funds are a ‘copy’ – mirror – of the underlying mutual fund, created by an insurance provider and established under insurance, life and pensions funds rules. Providers launched these funds for their own products and the annual management charges included costs for the fund manager and may have included an element of cost relating to the tax wrapper. Performance of a mirror fund is different from the underlying mutual fund due to the cost differential, taxation and potentially the pricing of the fund being carried out at a different time to the mutual fund it is ‘mirroring’. On the plus side, switching between funds is easy with providers able to match, buy and sell deals within the fund to keep transaction costs low for the customer.

Investments through today’s platforms are directly into the mutual fund itself, aiding transparency of cost and ownership. Similar to mirror funds, many mutual funds have ‘bundled’ costs into one price, challenging the transparency being sought.

With the levels of new business flowing through platforms into mutual funds, bundled share classes are widely used today.

These mutual funds take us closer to transparency but because of how they ‘bundle’ costs into one price they are only a step on the way.

The costs of bundled share classes cover ongoing fund manager charges and expenses including a cost – rebate – for the provider that may or may not be passed onto the client. Units held before the RDR may include an element of trail commission for advisers. Of course, how platforms deal with bundled share classes varies. Many platforms reinvest the rebate into the cash element of a client’s plan, while others retain the rebate to fund their platform services.

In some instances, where a fund house did not offer a rebate or was small in comparison to others, it may have resulted in the platform provider not hosting the fund. Thankfully the steps now taken by the regulator have addressed this. There is also a difference in the level of rebates negotiated between the platform and fund house, so investments in the same fund may result in a lower cost. Through a number of policy statements the regulator has introduced greater disclosure of charges, leading to the costs of units being unbundled. In other words fund management charges and any rebates paid to platforms must be separately identified and disclosed to customers. This certainly supported better understanding, although the regulator wished to go further.

Following various FSA papers it is the FCA who published the final guidance after a number of industry consultations, resulting in changes to how the industry deals with the rebate within a unit. As has been well documented, the reinvestment of the rebate into a cash element of a client’s plan is no longer permitted from April of this year – for new money at least – and at the same time platforms are unable to retain the rebate for themselves – again for new money.

In the first quarter of 2013 HMRC issued guidance confirming the rebate, whether made as cash or reinvested as units could give rise to an income tax charge in the hands of the investor. And so the launch of new units gathered pace as more fund houses launched new share classes referred to as clean share classes.

One thing is for sure, clean share classes are certainly more straightforward for clients to understand, supporting our journey to transparency. With no rebate included in the price, this share class only contains the cost of fund management and with no rebate there is no consideration needed of the tax the investor may otherwise have incurred.

Of course, there is no trail commission paid either, as now, post-RDR, advisers have transitioned business to adviser charging.

Interestingly the annual cost of clean units for clients has fallen, although not in all circumstances as fund managers may not be willing to offer ‘best’ terms to all.

We have been on quite a journey and made strides in reducing complexity. But with many fund groups making clean share classes available, it is important we do not interchange terminology that infers that unbundled and clean are seen in the same light.

This is no doubt a matter of personal opinion. For instance, looking back at how clean share classes have been described here, I have heard mentioned that a unit is clean if the rebate has been reinvested. But in my opinion, just because the rebate is no longer retained by the platform provider does not make it clean.

This interchange of descriptions appears to be increasingly common when looking at super clean units – more on these in a moment. For units to be described as clean, even when the rebate is reinvested for the client, has the potential to add further confusion. The challenge for advisers is getting behind the jargon and understanding what is actually being described and what the implications are for their clients.

Put simply, super clean is a version of clean with a lower cost, issued under a different share class which is not available to every platform provider.

Another challenge is that the lower cost is sometimes derived from fund managers providing a larger rebate, which is reinvested – so not clean in my eyes – and which opens itself up to potentially greater levels of HMRC tax.

So even a ‘clean’ share class in the eyes of one platform may not be ‘clean’ in the eyes of another if they have secured a rebate.

Without a consistent naming convention for share classes, fund managers will continue to choose their own – retail, A, platform, X, institutional, W and more – so care needs to be taken when selecting funds. Having new share classes, essentially new funds, may impact an adviser’s review process as there will be limited historical pricing.

It is important therefore, for advisers to ask how platforms are dealing with rebates, super clean and the like, as it is clear terms used across the industry by different people mean different things. When carrying out due diligence, be sure to ask questions around share class strategy.

Alistair Wilson is head of retail platform strategy at Zurich UK