Last week Legal & General launched what can claim to be the lowest-cost PEP investing in shares. It also reduced charges across a range of other plans.
It was the latest move in a hard-fought price war that really has brought better value for buyers. Disappointing sales, too many companies competing - including some aggressive new entrants like Virgin Direct - and a desire to lure savers from the building society are combining to attack prices. Despite a lucrative year for stock market investors, the lack of a "feelgood factor" has kept buyers away.
Our table lists four PEPs that are among the cheapest ways for savers to invest in the UK stock market. They also offer good prospects for above- average performance and a fairly straightforward investment aim.
PEPs are the best way into the market for most people. Big attractions are that income and capital gains are tax-free and you can cash your money in at any time. None in the table are the new bond PEPs (see story below), which offer higher income but much lower - if any - potential for growth. Unless you need to take the income now, you are probably better off investing in PEPs whose underlying investments are shares.
Announcing its price cuts L&G said it believed potential investors were put off by the huge choice of PEPs. There are hundreds available, most of which are in effect tax-free unit trusts. "People are confused. They want simplicity. And they're sceptical of everyone claiming top performance," says L&G's marketing director, Stephen Abbott.
All the PEPs in the table aim simply to match the performance of the UK stock market, rather than beat it as with most PEPs investing in UK shares. Hence the index or index-tracking title. And by and large they should do that, although they do normally underperform slightly due to charges. That makes their performance relatively easy to monitor. If you read that the stock market is up or down 10 per cent, the value of your investment should be up or down by a similar amount. Performing in line with the market has also made them above-average performers overall, particularly in the longer term. Most unit trusts underperform the stock market, despite their claims of investment expertise.
And the latest charge squeeze should help the comparison. Many non index- tracking PEPs still have buy-sell costs of up to 5 or 6 per cent and annual fees up to 1.5 per cent. Lower charges mean more of your money is working for you. Higher charges mean a bigger drag on performance - the fund has to do that much better just to keep level.
So which is best? Virgin has made the most noise since its launch in the spring. But Gartmore has a record of tracking the market with reasonable success for more than five years. Only L&G pays commission, so don't expect financial advisers to wax lyrical about the others. L&G's 1.5 per cent commission means that if you can get a discount from an adviser, you get invested even cheaper. Discount brokers might share up to half this commission with you.
What then are the catches?
o Low cost is not no-cost. All four PEPs in the table make no initial charge for the investment. But three have hidden charges, which we show in the table as the buy-sell cost. Unlike a building society account - where pounds 100 deposited is worth just that - pounds 100 into most of the PEPs in the table will have an immediate cash-in value of pounds 99.50, even if the market doesn't move. Virgin waives this 0.5 per cent cost for PEP-holders after five years.
o Cheap PEPs can require quite chunky investments. To get the quoted charges, Virgin and Gartmore require at least pounds 1,000. Both will allow you to save from pounds 50 a month, but then there is an additional pounds 2 flat charge. That makes their charge structures much less favourable. Currently L&G will only allow investments of at least pounds 3,000. Only HSBC charges the same whether you invest pounds 50 a month or a pounds 1,000 lump sum (the minimum one-off).
o Cost isn't everything. The funds may fail to follow the market, although tracking is successfully established among big investors such as pension funds. Virgin has the shortest record. Some higher-priced funds that aim to beat the market will inevitably beat the trackers, despite the charge disadvantage. Peter Jeffreys, managing director of Fund Research, says there are a number which he would expect to outperform the market over a reasonable period. He names Schroder UK Equity, Perpetual UK Growth, Mercury British Blue Chip, Schroder Income and Morgan Grenfell UK Equity Income as being suitable PEP choices for first-time stock market investors. And in each case you can invest cheaper - although still not as cheaply as the trackers. Discount brokers will sell the named funds at a discount of up to 4 per cent.
o PEPs aren't for everyone. Their tax-free status should not be the main reason for investment; they still carry the risks of the stock market. You should only invest money that can you afford not to touch for at least five years to give yourself the best chance of outperforming the building society.
o The stock market is close to an all-time high, and while it may not be heading for a crash, it certainly isn't cheap. Investing in a tracker PEP now could mean you don't see much growth for some time. By waiting until the new year investors might be able to invest when the stock market is at a similar level. And there might even be more cost-cutting - giving even cheaper PEPs or even more choice.
Cut-price stock market PEPs
PEP Buy-sell Annual Returns1 % Returns %
cost % fee % over 6 mths over 3 yrs
Virgin Direct Growth 02 1 +14 n/a
Gartmore UK Index Fund 0.5 1 +15 +60
HSBC Footsie 0.5 1 +12 n/a
Legal & General
Index-Tracking 0 1 max3 +14 +57
UK Stockmarket4 - - +15 +62
Average Pep5 - - +13 +54
1 Returns are growth with gross income added back, and excluding buy- sell costs.
2 Assuming PEP held for 5 years. Buy-sell cost is the difference between buying and selling prices today.
3 Based on charges of 0.5% + pounds 25 (+VAT.)
4 FT-SE-A All-Share index with gross income added back.
5 Based on average performance of general UK unit trust.
Source:The Research DepartmentReuse content