Broker charging: where are we now?
It has done this principally by banishing the payment of trail or return commission from fund managers to those who sold or distributed their funds. Instead, those distributors – your broker – will have to charge you directly.
These changes came into effect in April 2014 for new business and come into effect in April 2016 for legacy business.
So, half way through that change where are we? In reality the landscape is more complicated and confusing for personal investors now than was the case with a range of different business models emerging. Investors should make sure they understand the charges their broker will levy and make sure they fit with their investment behaviour and objectives.
Emerging business models fall largely into two camps. Those charging a value related fee – effectively directly replacing the value related commission they received from fund managers – and those charging a flat fee. If only it were that simple! Typically in the value related models, fees are tiered dependent on the value of the account and in some cases include dealing costs and in other cases don’t. Charges may also vary dependent on the asset class – funds, equities, investment trusts etc.
The structure that is best for you will depend on your portfolio value, trading behaviour and long term objectives.
Broadly, value related charges, especially those which include dealing commission, favour lower value portfolios and those with high trading frequencies. Fixed fees favour those with higher and growing portfolio values and those who trade less frequently as dealing commission is invariably charged on top.
This difference is evident if we look at an example. Imagine you open an investment ISA expecting to trade 5 times a year and have the full £15,000 to invest. On a charging structure of 0.40 per cent per annum, including dealing commission and without VAT (an added complication!) you will pay £60 pa. If instead, the charging structure was £5 per month (including VAT) with £10 per deal you would pay £110. The value related environment works out best.
However, if you expect the £15,000 to grow or you expect to invest your allowance again next year the story looks quite different. Now, with £30,000 in the account and assuming the same dealing frequency, you would pay £120 in the value related environment but still £110 in the fixed fee environment. As your account grows or you make further contributions that difference will increase over time. This is a function of the value related fee environment taking a piece of any investment growth or increased account value arising from additional contributions.
From this example it is possible to see the dynamics of value related charges that favour lower value higher trading frequency accounts. Fixed fees favouring the growing portfolio and buy and hold investors. This is though a simplistic example and no model is quite as clean as in this example – investors should be aware of other charges in particular – for example related to reinvestment of dividends, regular savings, receiving company reports etc.
In the long run at The Share Centre, we believe the intermediary (i.e. the execution-only or self-select) broking market will move to flat fees. There is little correlation between the costs of administration for an account and the value of that account – so why should charges be linked to the value of the account. Investors will realise this over time and new entrants to the broking market will not be burdened by a mindset rooted in the days of trail commission and a belief that revenues should be driven by the value of assets under administration.
Finally, the other aspect I would urge all investors to ensure they are clear about is whether the funds they are invested in are still paying their broker trail commission.
If you have held funds since before April 2014 and have not asked your broker to transfer your holding into the ‘clean share class’ (i.e. the share class for that fund which does not pay trail commission) your broker may not have actively transferred your holding (they don’t have to) and between now and April 2016 when trail commission on legacy business ceases you may find yourself paying a higher annual management charge on the funds you are invested in as your broker continues to take trail commission. On a reasonable sized portfolio this could be quite significant.
In short, charges remain a minefield and while in the longer term they should become simpler and more transparent, in the short term as RDR is fully implemented, they remain complex and difficult for investors to navigate and compare.