PlatformsAug 21 2013

New platform share classes: Clean but complex

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Debate is heating up about so-called clean and super-clean share classes with Jupiter, for example, recently announcing it is not going to commit to new pricing in the wake of continued uncertainty around the Retail Distribution Review.

Clean funds (with the trail commission removed) are the response to the RDR requirement for the abolition of rebates But super-clean has been mooted as a way to meet the demands of large distributors or buyers looking for a better price for the funds they buy. This in essence replaces the behind-the-scenes additional commission payments or fund rebates that existed pre-RDR. One assumes that the better price will be sought on the basis of greater promised sales volume or improved operational efficiency.

It is odd that clean funds are replacing rebates, while new super-clean funds may require the payment of an additional rebate – unless a completely new (lower annual management charge) share class is created.

I am going to look at the various players in the market to assess the impacts on each of these potential new share classes and rebates.

Competition

Any price competition will impact upon asset manager business models. Each new share class will have establishment and running costs and further costs if the share class is subsequently closed. With many commentators already arguing that we have an oversupply of funds and share classes, the addition of clean and super-clean ones can only negatively impact margins. Managers will therefore want to limit the number of new share classes. Some are already converting ‘dirty’ funds (with rebates) to clean funds to avoid the need for tax inefficient rebates to be made to investors. Having the manager make the transition rather than the investor avoids the potential impact of capital gains tax on the transition.

This debate comes at a time when the passive and index managers with their lower cost funds are already taking assets away from incumbent active managers. RDR is also forcing advisers to look at all investment, trading and product costs and place pressure for reductions for clients wherever possible.

Will the regulator see clean and super-clean funds as a form of cross subsidy?

Larger fund groups will have concerns about discounting – their global distributors will be watching UK developments and presumably would want access to cheaper share classes to be replicated in their jurisdictions.

Managers may decide that, commercially, it makes sense only to offer discounted fees if appropriate operational processes are in place – they may insist on straight-through processing before allowing access to a cleaner price. We may see the concept of dirty pricing – the funds are clean if you can buy completely electronically, or ‘clean-plus’ via a platform or ‘clean-plus-plus’ without e-trading (telephone or paper deals). This is not dissimilar to the days when paper-based term assurance had a higher fee than online applications.

Direct-to-consumer brands look set to grow in importance post-RDR – and one assumes these retailers will look for discounts. These channel price wars may well see prices driven down. On the other hand, it may see a reallocation of costs – perhaps the cost reduction demanded by some distributors on their clean shares will see additional costs passed on to unclean share classes. And, of course, the headline AMCs are only part of the equation – as we saw with the advent of fund supermarkets, the total expense ratios on a number of shares classes rose in response to the margin being taken by the platform. TERs may rise faster than the AMCs fall.

The growth of direct fund management and model portfolio management will surely also see these ‘distributors’ demanding a better price and they may well have the operational infrastructure to support electronic for dealing and settlement.

The supermarket and wrap platforms, already facing margin pressure, must be pulling their hair out at the prospect of more share classes and different rebates. One assumes they will want to be paid for the additional admin burden or want to pass on the costs for the different operational arrangements.

Questions for managers and platforms to resolve, will include:

- Will all the platforms be able or willing to support multiple clean share classes?

- Who is responsible for the key investor information documents for each?

- Does the tax treatment of any rebates make the whole process futile (lower costs, more tax)?

- What are the operational and sales impacts of these changes?

RDR is still playing out; the banks (for now) are sitting on the sidelines. The investor is apparently confused about advice and now has the prospect of being further confused by different prices for the same fund, so questions such as these may well be asked:

- Can I re-register my old dirty fund for the new clean one?

- Will information as to the cheapest channel from which to buy funds be in the public domain?

- Why is the super-clean fund only on some platforms?

- I like my adviser but are the recommended funds cheaper elsewhere?

The concept of clean and super-clean is clear – in most walks of life, the more you buy of something, the cheaper it becomes. And the simpler the buying process, the more sales in aggregate occur. Our industry seems to be trying to make the whole process more complex.

Operationally, multi-share classes is challenging at best – for managers and platforms. We have only just got a half-decent re-registration process (thanks to the Tax Incentivised Savings Association and Tex) for transfer between platforms – the impact of trying to do the same thing with multiple share classes (and adding in different rebates) is far from simple to keep track of for advisers, and harder still to explain to customers. This operational complexity and risk will need to be paid for by someone.

The regulator has already stepped in to outlaw platform and fund cross-subsidy within groups – will it see clean and super-clean funds as a form of cross subsidy? It may be nervous that this activity creates the opportunity for some cosy deals where incremental margin is created at the investors’ cost.

Growth

Passive funds are already seeing their share of market grow, and that looks set to continue – the debate around clean shares classes may have limited direct impact on the pace of this growth unless the complexity of pricing of active funds proves to be an operational barrier. Active mangers still need to show the value they add more clearly – and in a world of growing transparency, this pricing fog may be an unwanted distraction.

Transportability is no doubt something the FCA will be keeping a keen eye on. It will also be looking at transparency to make sure there is no cloak and dagger pricing with lower AMCs and yet higher TERs.

Advisers will need to look ever more closely at the total cost of ownership – the AMC and the TER have always been on the radar – now the costs of trading and dealing for active funds may need to be added (as they are for exchange-traded funds already).

Passive managers may see further wind in their sails but we should not forget that asset allocation (to meet investor goals) is arguably the most important element of investing decision making – advice therefore remains valuable while lower average investment costs are certain to boost return.

David Norman is founder and chief executive of TCF Investment