Deciding on the right investment funds for your portfolio can be challenging enough, but the selection process does not end there: once you have made your decision, you are likely to be faced with a bewildering array of share classes in each fund. To add to the confusion, if you are looking at a fund's past performance it may not be obvious which share class is being measured. The situation has become more complex since new regulations were introduced under the Retail Distribution Review, which came into force at the beginning of 2013 and was meant to empower investors. Investors will find that most funds have four, five or even more share classes. There is no industry standard for naming share classes, which makes comparisons even more difficult. They are named differently by each investment company, normally using a motley selection of letters from A to Z. The number of share classes per fund may be increased if there are special classes for larger institutional investors such as pension funds, or if it is a fund that invests overseas and has a share class hedged back to sterling, or if the fund is available to overseas investors and provides share classes in other currencies. Most share classes are also available in 'income' and 'accumulation' versions. Thankfully this terminology is standard across the industry and is relatively simple to understand. But how do investors know whether to choose A or B, or X or Y shares? Even financial advisers admit that it can be confusing. Mark Waters, investment manager at Skerritt Consultants, says: 'It is horrendously complicated for private investors who have multiple share classes in a fund.' The most obvious thing to do would be to choose the share class with the lowest charges. A fund such as Old Mutual UK Alpha, for example, has share classes with annual management fees of between zero and 1.5 per cent. But if you look at a website such as Trustnet, which carries information about different funds, the minimum investment required for the cheapest share class can be as high as £250 million. But this does not mean that private investors have to opt for the share class with the lowest minimum investment and the highest management charge, which is normally denoted with an A or an R. Financial adviser Justin Modray of Candid Financial Advice explains: 'This share class, which was typically sold pre-RDR, has all the charges bundled together, including the investment manager's fee, the commission paid to the adviser and the cost of using a platform.' This share class is sometimes described nowadays as the 'dirty' share class. This share class was also sold to investors who bought funds directly from fund managers. Managers used the higher charges to cover the extra administration costs of dealing direct with investors. But most companies no longer deal direct.
INCOME VERSUS ACCUMULATION
With income shares, any income generated by a fund's underlying investments is paid out to investors in regular distributions. With accumulation shares, the income is reinvested back into the fund, increasing the price of the shares - so these are most suitable for investors looking for capital growth.
Ross Leckie, director of communications at Artemis, one of the few providers to have just two share classes - R and I - in the majority of its funds, says: 'If someone phones us and asks to invest in our old-style R share class, we try to put them off and encourage them to go to an adviser or to a platform.'
Because of the higher cost of the R/A share class, Justin Modray believes it will gradually 'wither on the vine'. But some companies such as Invesco Perpetual are still selling these shares to direct investors through regular savings schemes, as well as via lump sum investments. Investors can buy them in funds such as the ever-popular Invesco Perpetual Income.
James Rawson, head of platform distribution at Invesco Perpetual, argues that investors are not necessarily paying over the odds.
He explains: 'We want to offer investors a range of ways of accessing our funds. Although direct investors do pay more at a share class level, they know exactly what they are paying, whereas investors who buy through a platform or an adviser will need to take the additional platform costs and any other fees into account to work out their total annual costs.'
'NO TRAIL' CLASSES
Rawson explains that the four share classes in Invesco Perpetual Income have come about mainly as a result of regulatory changes due to RDR and platform regulation.
'Besides our basic shares for direct investors, we also have a "no trail" share class with a 1 per cent annual charge, which was introduced in 2009 for advisers who were already starting to charge fees rather than relying on commission.
'Then there are the Y and Z share classes sold through platforms. Generally, the Z shares are available through platforms and the Y shares are available through the five largest platforms, offering particular economies of scale.'
Another fund manager that still sells direct to investors is M&G. Its funds have an A share class for these investors, as well as an X share class, which was originally offered in the days when initial charges on funds were the norm.
It offered the option of no initial charge and tiered exit fees instead, falling to zero in year five, to encourage longer-term investment. However, this share class has become redundant now that initial charges are normally waived anyway.
Since the beginning of 2013, fund managers have had to offer an 'unbundled' or 'clean' share class, typically with a 0.75 per cent annual charge.
Since that time advisers have had to charge investors a fee for their services and are no longer allowed to recommend shares that pay them a trail commission. Since April 2014, platforms have also had to make an explicit charge for their services and are now selling the clean share class.
Nowadays, most managers prefer investors to deal through platforms because it means less administration for them.
When Neil Woodford's new fund Woodford Equity Income was launched last year, Craig Newman, chief executive officer at the new company, explained the reasoning: 'The CF Woodford Equity Income fund has four different share classes, each with a specific purpose.
'The fund's C, X and Z share classes are available to fund platforms and intermediaries that wish to offer our fund to their clients and have agreed terms of business with us. The A share class is intended for direct investors... It has a high minimum investment of £150,000 because we are a fund manager not a fund distributor.'
Although the majority of investors choose to invest via platforms anyway nowadays, it may still be confusing to see the minimum investments some fund managers stipulate for shares classes sold on platforms.
Minimums of £5 million or £50 million may be mentioned. In practice, individuals can often invest as little as they want because these minimums are the aggregated totals that platforms are expected to raise from their customers.
Indeed, because most investors do go straight to platforms, Ben Yearsley, head of investment research at Charles Stanley Direct, believes that in practice they are unlikely to suffer confusion over share classes.
'When consumers buy through a platform they will only be offered one share class anyway, with a choice of an income or an accumulation version. The important thing is that they know the charges on the shares that they are buying,' he says.
SUPER CLEAN
Some platforms may offer cheaper 'super clean' share classes that others don't. However, Justin Modray says, 'it is incredibly difficult finding out where you will get the best deals on funds. It is more important to look at how much you are paying the platform. Differences in platform charges can easily outweigh the negligible differences in fund charges.'
Even wealth managers do not always have it easy. Skerritts' Mark Waters says: 'We buy our clients the cheapest share class we can, but sometimes we have to press platforms to give us the best deal.'
Making direct comparisons between share classes in funds is not easy because of the different letters used by different managers. Waters says: 'This is one of our biggest bugbears. There is no rhyme or reason behind the lettering system. It would be much simpler if the industry could agree a uniform system.'
A spokeswoman for the Investment Association (IA), the fund managers' trade association, points out: 'There were never any rules governing how managers badged different types of share class.' But, like Yearsley, she does not think it is a problem because investors are only given one choice by platforms, although she does acknowledge that 'investors may get a better deal by shopping around'.
Whether investors who want to invest in, for example, Old Mutual UK Alpha would realise that the R shares they can buy through Chelsea Financial Services' Fundstore have slightly higher charges than the U1 shares in the same fund bought through Charles Stanley Direct is questionable.
CLASS PERFORMERS
Another problem that arises as a result of having multiple share classes is the issue of performance, and this is something which the IA is finally getting to grips with. It announced at the beginning of this year that it has been working with the main performance measurement firms to develop consistent and comparable performance data.
As a result the data providers are now in the process of identifying a primary share class for each fund which will be used in performance calculations in future. This share class will be the highest-charging unbundled share class, free of rebates or intermediary commission, and available through third-party distributors in the retail market.
However, because many of the lower-charging clean shares have only been in existence since 2012, the historic track record of funds will still be based on the old-style share classes until the overhaul is complete, with higher charges dragging on their performance.
Where a company has converted a cheaper institutional share class into its clean share class, then it will already have an historic track record based on these lower charges. The IA said that it cannot see a way around this problem, even though it acknowledges it will cause some inconsistencies in comparisons over longer time frames.
As a result, there is now a debate going on among some professional fund buyers about whether it would be better to construct hypothetical past performance records based on clean share classes.
Another suggestion is that no charges should be taken into account so that a fund's pure investment performance record can be compared. The reason for this is that investors' returns will vary anyway, according to the other charges they pay such as their platform charges.
So far, the Financial Conduct Authority (FCA) does not appear to have considered the impact of the plethora of share classes that currently exist. It published a paper last year entitled The Clarity of Fund Charges, which urged fund managers to show the ongoing charges figure (OCF) in their fund marketing material, rather than annual management charges.
The OCF shows a fund's total running costs, including legal, audit and custodian fees. But it will differ according to which share class the investor buys. An FCA spokesperson declined to comment on whether the regulator has any plans to look into share classes.
However, the FCA's Clarity of Fund Charges paper does state quite firmly that 'all firms must ensure their charges are clear to investors, particularly retail investors, so they know what they are paying for and can compare funds'. Any confusion among investors about which share classes they can buy won't help them to make these comparisons.
Some fund managers are also unhappy about the growing proliferation of share classes, but are pessimistic about the possibility of reducing that number any time soon. In the meantime, though, greater consistency in the naming of the share classes would go some way to making life easier for investors.
This article was originally published in our sister magazine Money Observer, which ceased publication in August 2020.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
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