Why have so many of the preferential fund deals announced in recent weeks been based on unit rebating rather than the launch of super clean share classes? Henry Brennan finds out
For a while, it looked as though the case for unit rebates was losing momentum. The tax implications announced in March, coupled with the promise of super clean share classes, looked substantial enough to take the argument in a different direction.
However, the unbundling of the execution-only platforms' pricing structures contributed to a renewal of the debate, particularly in the context of a slow trickle of super clean deals actually making it to the market.
Hargreaves Lansdown revealed its new pricing structure in January and with it the promise of cheaper fund deals for investors taking stock of its Wealth 150+ range.
Why have so many of the preferential fund deals announced in recent weeks been based on unit rebating rather than the launch of super clean share classes?
What became clear is that so few of these deals were on the basis of new share classes. Professional Adviser's sister publication Investment Week revealed that only 9 of the 27 funds on its Wealth 150+ list are available via preferentially priced share classes.
What this means is the platform with the largest distribution capabilities in the direct-to-consumer space went down the unit rebate route for 18 of the funds in order to secure the average annual management charge (AMC) of 0.54%.
Investors buying these funds outside of a tax wrapper will face an additional tax of at least 20% on any discounts.
HM Revenue & Customs (HMRC) ruled last year that, from April, it would tax fund rebates paid to consumers since they qualify as annual payments and are therefore subject to income tax. This became a prominent argument for moving away from rebates altogether.
Although the tax implications only apply to investments held outside of a tax wrapper, the tax implications are a significant enough of an issue to have prompted Hargreaves to mount a legal challenge of the decision.
Also on the execution-only front, Fidelity's Select list of preferentially priced funds on the Personal Investing platform are all achieved through unit rebating.
Fidelity head of business development Ed Dymott said fund managers currently appear to be favouring the unit rebates approach, in both the advised and direct-to-consumer arenas.
He said: "There definitely seems to be a trend for fund managers to favour rebates over new share classes at the moment. When we look at the range of discounts we have secured from fund managers, the majority seem to be via the rebate model. It seems to be that fund managers like the flexibility of the rebate. That can be turned off and on depending on the success of that structure."
Dymott says the decision to tax rebates represents a "fair compromise" between the regulator and the industry given that the landscape could be significantly less favourable for consumers had the regulator taken a different route.
He said: "As it stands today, we have seen more people use a rebate model than a share class model. I don't think that is necessarily a bad thing because, if rebates were not allowed, the question is whether our customers would have access to discounts today.
"Without a doubt, the Financial Conduct Authority (FCA) allowing rebates has meant that more fund managers have discounted their share classes and provided preferential terms and that has had a client benefit."
Fidelity FundsNetwork head Pat Shea was equally bullish on the outlook for unit rebates towards the end of last year as he predicted consumers would in 2014 see that super clean "is not so super."
Skandia has been vocal in its support for unit rebates as an alternative to cash rebates and outgoing Old Mutual Wealth vice-chairman Peter Mann said, while the argument is still in its early stages, there are clear indicators of which direction it is moving in.
He said: "While the taxation of rebates is an unpleasant and rather precipitous surprise, this does not destroy the purity of the argument. When we operated in a bundled environment, we aggressively negotiated unit rebates with the fund management groups.
"We benefitted as it was our remuneration before adviser charging. Why should that be different when the money goes to the customer? Why argue a different outcome just because you are not the beneficiary?"
Mann's view remains that the use of unit rebates will become increasingly commonplace.
What then of the alternative found in super clean share classes? There have been a number of announcements on this subject in recent weeks, most recently from Invesco Perpetual – it is launching a new discounted share class for five of the UK's largest platforms.
Standard Life has been the one of the most vocal supporters of the super clean approach and confirmed in September that it had agreed preferential share class deals with seven fund groups.
Since then, announcements on this subject have become less frequent but Standard Life is adamant that super clean is the preferable method to pass on discounts and the platform has elected to not support unit rebates at all.
Standard Life head of platform propositions David Tiller said he would expect unit rebating to have disappeared from the market altogether within the next two years.
He said: "Standard Life never asked FNZ to build unit rebating. However, I have complete confidence in FNZ's ability to do so if we had asked them to. For a number of reasons we have chosen to move away from rebates. They are at odds with our aim to operate in a clean [and] transparent manner.
"They also complicate statements, obscure comparison and are subject to tax. This is why we took the decision, with the support of FNZ, to bulk convert our advisers' clients at the beginning of the year to clean share classes, removing the rebate mechanism entirely from Standard Life platforms – an approach we are seeing more platforms beginning to adopt.
"A clean fund with a reduced TER/OFC is a far preferable method of passing on a discount. By 2016, I would expect unit rebating to be redundant and for the whole market to have moved to clean."
There are those who would go one step further by suggesting preferential pricing, almost in its entirety, will eventually become redundant.
Nucleus chief executive David Ferguson said IFAs are more concerned with choosing platforms that meet their requirements rather than whether they can be seen to shave a few basis points off the fund's AMC.
He explained: "I suspect if we run the clock forwards on this 24 months, there will be no differential pricing between platforms and it will all be done with clean share classes.
"It will be a temporary phenomenon just while the market transitions. Fund groups who are going down this road of discounted share classes for some outlets will realise in time that all they have done is create a race to the bottom across the whole distribution base."
What the last couple of weeks have shown us is that the argument for unit rebating is far from over. Whatever the final outcome, the issue has some distance left to run.
Tax implications: The story so far...
HMRC confirmed in March that unit rebates would be subject to tax from 6 April 2013.
HMRC said: "The payments made to investors are (in tax terminology) 'annual payments' and therefore subject to income tax in accordance with S683 Income Tax (Trading and Other Income) Act 2005."
HMRC added it would not apply the tax retrospectively to legacy holdings.
Hargreaves Lansdown chief executive Ian Gorham said the introduction of what the group is calling a 'discount tax' is "extremely disappointing news and an attack on the small investor".
"The 'discount tax' is anti-competitive. Loyalty bonuses have been hugely popular with investors and helped them save money on investing in their favourite funds. We have saved investors over £1bn in the form of discounts and loyalty bonuses, helping clients benefit from lower costs,"
Hargreaves said this legal challenge was likely to take several months.
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