This video is part of Morningstar’s special series about the Retail Distribution Review (RDR).
Video Transcript:
Alanna Petroff: As of 2013 the annual management charges that you’ll be paying on your fund are going to change and that could mean more money for you and less money for people in the industry. Joining me now to talk about these changes is Andy Pettit. He is the Director of Data and Research Strategy here at Morningstar, and he is a pro when it comes to RDR. So Andy thanks for coming in.
Andy Pettit: Thank you.
Petroff: Now let's talk about these changes, specifically to the annual management charges that are coming in with the new RDR rules?
Pettit: Okay, so the RDR rules, in part, start to transition advisers to be paid directly by the investor rather than via commission from fund companies. The way that the industry is dealing with that is to introduce a range of, what’s termed, “clean” classes, which excludes the element of commission from the fund. So for a typical equity managed investment fund, you’ve been paying a 1.5% management fee, which includes roughly 50 basis points to pay an adviser commission and 25 basis points to pay a platform for holding that investment.
Petroff: And then 75 basis points to the fund management company as well?
Pettit: Exactly right.
Petroff: Okay.
Pettit: So in the new world with these clean classes they just have the 75 basis points for the fund management and then you negotiate directly with your adviser and with your platform to pay those fees separately. So all-in-all it's a great thing because you get to see how much you’re paying to which part of the chain and are able to make judgments about the value of those payments.
Petroff: So, if I am an investor, I am investing with an IFA and I bought a fund in 2012, I am paying 1.5% annual management charge on this fund and the adviser is getting some money back from the fund company; the 0.5%. So, am I automatically switched into these new clean share classes as of 2013.
Pettit: No, you're not, and that's because there is no time limit on this transition to take place. So, the real trigger is when you next review your portfolio with the adviser and make material changes to it. At that point the payment basis has to transition. But there is nothing to stop you going to the adviser as soon as you like to start having those discussions and assessing the impact on you and the best plan for yourself.
Petroff: So you can go to your adviser and say, ‘I understand that I was paying 1.5%. I believe I still am, and the fund management company hasn't necessarily transitioned me to the new clean share class, I want to transition.’ And would they have to agree to that?
Pettit: Well, they would give you advice, and largely I think that would make sense to do so. I can't think of reasons why you necessarily wouldn't.
To put that into real money, if you invested in your existing class over 10 years growing at 5%, £10,000 would make a gain of something like £5,100, whereas if you do the same in a new clean class that gain would like more like £6,200. So it's a significant amount that you're paying and you can then make a value on how you pay the adviser going forward.
Petroff: Yeah, you want that extra money.
Pettit: Right.
Petroff: Okay. Now if you're investing on your own without an IFA, you're probably still paying that 1.5% annual management charge in 2012 and then potentially going into 2013, I suppose. Where does that extra 0.5% go?
Pettit: That goes directly to the fund company.
Petroff: Okay, they just get extra money off of you?
Pettit: Right.
Petroff: Okay. Do you go to your fund company as of 2013 and say I want to be switched into the clean share class as well?
Pettit: Absolutely you do. They may or may not agree to that initially, in that most of these classes are being set up for distribution through advisers and the economies of scale through larger asset pools.
Petroff: It's easier to work with IFAs who are selling product instead of individuals?
Pettit: Right. So to some degree the fund company will have some extra costs dealing with a lot of individuals. But I think peer pressure will hopefully see the industry put a lot of direct investors and then transition them from the old…
Petroff: … into the clean share class, okay. Finishing off here, what would be your final note to individual investors and what they should be doing about these clean share classes in 2013?
Pettit: I think it would be to learn as much as you can about them and go and have conversations either, with your adviser or with your fund company, if you're a direct investor, and just understand the impact upon you.
Petroff: Okay. Thank you very much for coming in.
Pettit: Sure, thank you.
Petroff: That was Andy Pettit. He's the Director of Data and Research Strategy here at Morningstar and I'm Alanna Petroff. Thanks very much for watching.
