Premium Bonds, Equitable Life & Dirty, Clean and Super Clean

With stock markets stabilising after recent volatility it is time to pause for breath and comment on a number of miscellaneous investment issues.

Premium Bonds

From 1/8/13 Premium Bond prizes have reduced the total payout, the number of prizes and the effective interest rate. For example the total value of prizes will be 13.6% less in August than July. According to National Savings & Investments (NS&I) the effective interest rate will fall from 1.5% to 1.3% p.a. This is the expected rate of return if an investor has average luck. Of course the beauty of Premium Bonds is that very few people have average luck. Someone who holds the minimum £100 could win a prize of £1,000,000 although my son with this sum has yet to win a single prize in 25 years!

The attractions of Premium Bonds are they offer the excitement of the unknown but potentially high returns. Capital is secure and can be withdrawn at any time. That said there may be a zero return and capital may be eroded in real terms by inflation.

Are Premium Bonds still worth considering? I think so. I have recommended them for clients with larger investment sums as a portfolio diversifier and alternative cash holding. With prizes being tax free, a 1.3% p.a. return is equivalent to a gross interest rate on cash of 1.625%, which is not bad compared to easy access savings accounts on offer. To remind you the maximum holding is £30,000 per person. Please note National Savings and Investments products are not regulated by the Financial Conduct Authority.

Equitable Life

The government set up a compensation scheme for policyholders who lost money from the collapse of Equitable Life more than 10 years ago. However there are fears that a large number of eligible claimants may miss out when the scheme closes in March 2014 as they are untraceable. If you have ever had an Equitable Life with profits investment or pension and think you may be affected for example because you have moved address please see http://equitablelifepaymentscheme.independent.gov.uk/

Dirty, Clean and Super Clean

No I do not refer to washing powder tests but I certainly do to a mess. I mean the unintended consequences of a significant change in financial regulation – the banning of commission and the impact on fund management charges. When this change came into effect for investments bought or switched into from 31/12/12 under the Retail Distribution Review (RDR) it led to the start of a process of unbundling of fund charges. Prior to the change a typical equity fund had a quoted and simple to understand bundled annual management charge. This was typically 1.5% p.a. and divided as follows – the fund management group kept 0.75%, the IFA received 0.5% in trail commission and a hosting platform such as Fidelity FundsNetwork received 0.25% p.a. Bundled share classes which are still in existence are referred to as “dirty” but they will gradually be phased out.

Where a pre-RDR fund is left intact the IFA still receives the 0.5% p.a. trail commission. However if a fund switch is made after 31/12/12 or a new investment made into a dirty share class the total charge is still 1.5% but the 0.5% p.a. previously paid to the adviser is rebated back to the investor. Fair enough you might think until HMRC decided to instigate a tax charge on rebates outside an ISA or SIPP. The rationale for these being deemed taxable “annual payments” is very spurious in my view as it is tax charge on a refund of part of the investment fee the investor has paid – it is not a new income.

Unbundling or creation of clean share classes led to the following typical change. The annual management was 0.75% p.a. The platform would then be required to charge their fee of 0.25% as an explicit charge on top and the IFA could add an adviser charge of 0.5% p.a. as well with agreement of the client. Hey presto this adds up to 1.5% p.a. the same as before. The benefits of unbundling it is claimed is greater transparency but in my view this is over-rated. I think consumers like an all in price – it is easy to understand and compare. Unbundled airfares from Ryan Air or EasyJet with add on costs is not always appreciated and I see no desire to unbundle supermarket or other retail prices. For example I don’t think many people wish to know how a £4 chicken is divvied up – how much goes to the farmer or producer (equivalent to the fund manager), how much goes to the supplier (equivalent to the IFA as intermediary) and how much to the supermarket (equivalent to the platform).

A storm in a tea cup perhaps you are thinking. Except in many cases the net charge on a dirty share class taking the 0.5% rebate into account turns out to be higher than a clean share class of the same fund. This occurred because some fund managers sneakily raised their charge on clean share classes from 0.75% to 1% p.a. This wasn’t meant to happen. Clean share classes were expected to be no more expensive than dirty ones. For IFAs making investment recommendations there is now the added complexity and cost of not only recommending the right fund but the cheapest share class. Previously the only decision was to select an income or accumulation share class. IFAs may justifiably pass on the costs of the extra research to their clients.

A further complication is the creation of super clean share classes. Here a platform with large purchasing power demands discounted charges for hosting funds from a fund management group. For example instead of the standard 0.75% p.a. they may ask for 0.1% to be shaved off. All good for the consumer you might think but it is leaving other platforms miffed if they don’t get the same discounts and creates problems with re-registrations where funds are transferred from one platform to another. If the receiving platform does not host a super clean share class the re-registration can’t occur and the investor is stuck with the old platform they were seeking to exit. Super clean share classes will also put pressure on fund manager group margins who ultimately foot the bill of lower fees. A race to the bottom will surely be bad for investors if fund management companies have to lose key analysts to pay for the discounts and investment performance suffers as a result.

RDR has opened a Pandora’s box of unintended consequences. It was meant to be clearer for consumers; it has got a whole lot more complex. In the famous words from Laurel & Hardy – “That’s another fine mess you’ve gotten me into.”

You should seek financial advice before making investment decisions.