What will funds look like post-2012?

Julian Thomas, head of product development at LVAM, looks at possible fund charging structures in a post-RDR world.

I hope that 2011 will bring you health, happiness and, who knows, even wealth. If I sound sceptical about the wealth bit, it is because my commuting costs have just shot up; the price of food is doing the same and, of course, we have just had the VAT increase.

Now at an all-time high of 20%, VAT is double the original 10% rate of 1973 (even the VAT rate is something to be nostalgic about). After digesting all that, in April there is the National Insurance Contribution (NIC) rate increase to look forward to. All this talk of three-letter abbreviations brings me seamlessly on to the RDR.

The RDR is now less than two years away, as if you needed reminding. If you are a financial adviser, perhaps your main pre-occupations are around professional qualifications, your business model (independent; restricted), remuneration, client segmentation and other key issues. Maybe you are well advanced, through most of the pain, and just waiting for the final rules on platforms to be published.

Either way, let me say that as asset managers, we share your pain. Until the platform rules are published around June 2011, we can still only speculate about the product features and charging structures required for the brave new world of RDR.

In short, there are still some unknowns about RDR, but if we work together, we can give you, your clients and ourselves the best possible outcomes. I would like to focus on a few areas of mutual interest: platforms, share classes and the facilitation of adviser charging.

It was no surprise that the FSA bowed to pressure from the big supermarkets to allow AMC rebates to continue in respect of the administration services they provide. More unexpected was the regulator’s decision to hit the wrap providers by proposing a ban on AMC rebates to client cash accounts, just when we thought the wrap model was positioned closer to RDR.

It now remains to be seen whether the wrap providers can use the current consultation period to overturn this.

Share class options

Until the platform rules are published, we can still only speculate, but it is shaping up as follows:

Most asset managers currently operate a ‘full fat’ retail share class (typically 1.5% for an alpha equity fund). This will continue for legacy business paying commission/AMC rebate to advisers and platforms alike.

With commission banned on new business, a ‘semi-skimmed’ share class will probably be needed. For example, a 1% AMC with propensity to pay AMC rebate to supermarket platforms. At LVAM, we already have one; many of our peers will need to start building.

Then we might also need, you guessed it, a ‘skimmed’ or ‘factory gate priced’ share class for non-platform IFA business and possibly for the wrap platforms. This might have an AMC in the 0.5% to 0.75% range. This could potentially serve as an institutional share class, which many asset ­managers have already.

I fully anticipate that platforms will have the necessary functionality to support this. Wraps, for example, already have client cash accounts to do so. Even if cash rebates to clients are banned, investment in income producing assets should provide a sufficient income stream to prevent the cash account from running dry.

With the majority of financial advisers now using platforms, the asset management community has to decide whether it also needs to facilitate adviser charging on direct investments, that is, on non-platform advised business.

With no cash accounts at our disposal, such payments would probably be derived from the cancellation of units. Associated with this are potential CGT and VAT issues and all the reporting that goes with it.

It is estimated that the costs of building and running this functionality would be considerable – and alongside the ‘semi-skimmed’ share class, with no such functionality, we would need a ‘gold top’ share class as well.

This share class, with all the bells and whistles, could resemble the current ‘full fat’ class in terms of TER. The client would then see units cancelled on top to pay adviser agreed charges. This is complex and expensive for clients – the exact opposite of what the RDR intends to achieve.

There is growing sentiment in the asset management community that facilitating adviser charging is best left to the platforms, and that we should stick to what we do best which is delivering superior investment performance.