As the debate about trail commission rumbles on, I thought it may add some perspective if I outlined how unit trust commission has developed over the last 40 years or so from a product provider’s perspective.
To understand where we are, maybe we should recall how we got here.
Back in the 1960s, unit trusts paid 1.25 per cent initial commission – then the standard rate of commission on share deals paid to stockbrokers which was fixed by the Stock Exchange. Unit trust sales through what were then termed ’insurance brokers’ were negligible. Sales were dominated by three main outlets – direct advertising, some sales through stockbrokers and accountants – and to institutions.
At this time unit trust charges were also fixed by Board of Trade regulations at 13.25 per cent over 10 years. So you could charge 3.25 per cent initial and 1 per cent a year. Or 5 per cent initial and 0.825 per cent annual.
To pay for more advertising, most firms went the latter route to maximise immediate volumes. (And more volume meant more “box profits” – a story of hidden charges for another day).
Also at this time, regular premium insurance policies had some tax advantages. Therefore the larger fund groups (Save & Prosper, M&G, Target) started insurance subsidiaries that offered unit-linked insurance which could charge what they liked and paid much more commission to brokers and their direct salesforces. These were the institutions which were the third main unit trust sales outlet.
Two things changed in the early 1970s. The long bull run of the 50s and 60s wobbled which unnerved direct investors and the 1972 Finance Act made the tax advantages of unit trusts for lump sum investment more obvious. Advertising stopped being profitable and “insurance brokers” became more interested in unit trusts.
But they could not live on 1.25 per cent commission, so one of the faster rising boutiques – Jessel Britannia (now Invesco) of which I was marketing manager – offered Julian Gibbs (for it was he – then heading a large broking firm) a “marketing allowance” of 1.75 per cent effectively taking initial commission to 3 per cent. After much grumbling the industry followed suit and the pattern of distribution changed greatly to become dominated by the advice sector.
Things improved for the industry when Mrs Thatcher’s free market reforms included abolishing the old fixed limits on unit trust charges. This allowed managers to push up annual charges and reclaim margin.
In 1987 two more factors changed commissions.
First Peps were introduced and the stockmarket crashed. Unit trust sales were smashed so selling Peps seemed a way forward. However the PEP limit was £2,400 and 3 per cent of £2,400 was £72 – not a lot.
However, the industry (led by Invesco though by now I had moved on) thought that if an IFA could sign up a regular premium Pep with trail commission he would get a much greater future income stream and it would be worth the struggle to sell a Pep which was now much more difficult after the market shock.
Regular unit trust savings plans had generally been a loss leader because investors usually stopped contributions after two or three years. But it was thought that the tax break would mean investors keeping their Peps and adding to them for some years to come.
Once the industry had conceded the principle of trail commission, there was no turning back and it spread to all purchases. Undoubtedly unit trust charges crept up some more to regain the margin which had been lost.
So commission was always used by product providers to get business from advisers. It was increased when times were tough to try to keep volumes moving. It was a margin/volume decision for providers. It was necessary given the higher commissions paid on more expensive insurance products which could be offered because of the opaque nature of their costs. It was over time recouped by increasing charges – and by ad valorem charges on funds rising faster than fixed costs as stockmarkets continued to grow.
It was never a payment for service. It was always to generate sales and by so doing helped both fund managers’ sales and the growth of the advisory sector.
Because commission rates always moved to a new standard, they were rarely a reason to prefer one fund provider over another.
It has been, however, a reason for advisers to prefer equity funds over cash products. The UK is peculiar in the amount of equity products held particularly by smaller private investors compared to Europe where far more is in cash and bonds – and the marketing aggression of non-bank asset managers is one of the reasons – though by no means the only one.
My guess is that the RDR will in the long run see the UK savings market move to a much more continental profile. This may or may not be beneficial – but that is a whole other debate.
Richard Eats is former managing director at Henderson and former marketing director at Threadneedle and Cofunds