Pepping up the equity: Will price cuts boost or kill off investor demand for unit trusts? Caroline Merrell investigates

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The Independent Online
THIS autumn the price war that has been raging between fund managers on personal equity plans seems set to escalate - with dramatic results. New rules from the Securities and Investments Board are due to come into effect - no exact date has yet been fixed but October looks likely - that will allow managers to offer unit trusts that have no front-end charge.

Front-end charges arise because unit trust companies refuse to buy back unit trusts at the same price as they sell them to the consumer. The higher price at which they sell unit trusts - the 'offer' price - and the lower price at which they buy - the 'bid' price - are supposed to reflect the administrative and marketing costs to the company of cancelling and creating the units.

The degree to which they do, or the extent to which these costs are being covered by management fees charged during the period for which the unit is held, is unspecified. Offering units free of any front-end charge, however, has been possible only for units that form part of personal equity plans.

The resulting battle for customers is likely to be fierce. Any intensification of the war could lead to consolidation among unit trust companies, as only the big companies are able to withstand the subsequent erosion in profits.

The industry has already had a taste of what might be in store for it. Earlier in the year, the UK's biggest unit trust manager, M&G, scored a marketing success by scrapping the front-end charge on units which formed part of its managed income PEP. M&G replaced that spread - which in effect amounted to a charge of 5 per cent - with a staggered exit charge that dwindled away to nothing if the investment was kept for five years.

The change in the charging structure was backed by a multimillion- pound advertising campaign. Unfortunately for M&G, the poster ads had to be withdrawn because they did not make the exit charge clear enough. Despite this, the promotion caught the imagination of the investing public, and just before the end of the tax year, M&G was taking more than pounds 1m a week. Many companies followed suit by introducing one-off deals on their PEPs.

But offering discounts has its price. M&G's interim results for the six months to March reveal that the company has been forced to make a provision against future profits of pounds 4.9m, because of the offer.

A large part of the provision arises because M&G distributes its products via independent financial advisers. No front-end charge means the company has to pay the commission immediately and hope to recoup it from the annual management charges on the fund, which are between 1.5 and 1.75 per cent.

Geoffrey Mushens, M&G director, said: 'The IFA (Independent Financial Adviser) commission costs a lot, and there are other marketing costs. We thought it would be sensible to spread the costs over five years. ' Three per cent commission is the norm for unit trusts.

When the SIB rule changes come into effect in the autumn, M&G will lead the way again. It is already considering scrapping the front-end charge on one of its funds, although again it plans to add an exit charge.

If this is successful, it would then consider dropping the front- end charge on some of its other unit trusts - again, at a price. Mr Mushens said: 'If we did this, we would have to make the same kind of provisions in our accounts, as we did for our PEP.'

Other unit trust companies believe that this continued downward pressure on price could lead to a spate of takeovers.

Small fund managers do not have sufficient profit margins to fund intermediary commissions, neither do they have the marketing muscle to buy the business volumes to build up these margins by increasing income from the annual management charge.

Richard Royds, Mercury managing director, is not convinced about how investors would perceive the replacement of an initial charge with an exit charge. 'Investors may not react that favourably to them,' he says.

In a falling market, for instance, the exit charge would be an extra loss for people wishing to sell their investments in a hurry. He also believes that as so many unit trust companies are part of much bigger organisations, they may be cushioned against a price war.

Keith Crowley, Invesco director, says: 'Until 1987, most unit trust companies made their profits on the initial charge. Now the emphasis is on the annual management charge. The pressure on small unit trust companies will become intense. They will have to build up sufficient critical mass to make money on the annual management charge.'

Invesco, which has funds under management of pounds 1.2bn, recently cut the initial charge on its entire range of 32 unit trusts to 3 per cent. It did not add an exit charge.

One large player that has no intention of altering its charging is Perpetual. Martyn Arbib, chairman, says: 'The above-average performance of our funds means that independent financial advisers will continue to give us business.' He says that even without discounts, unit trusts are a cheap form of saving, compared with single-premium bonds or endowment policies.

This disparity in price between different savings products will be brought into focus at the beginning of next year when, for the first time, consumers will be told in cash terms before they buy an investment product how much it is going to cost them - both in terms of commission to the adviser and of the expenses of the company.

Commission rates on single-premium products sold by life assurance companies such as with-profits bonds or distribution bonds are nearly 75 per cent higher than those on unit trusts.

Commission on a pounds 6,000 investment in a single-premium bond from a life company would be about pounds 315; commission on the same investment in a unit trust would be pounds 180. This vast price disparity may help to stave off any dramatic fallout from a price war by increasing investment in unit trusts across the board.

(Photograph omitted)

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