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Take the exit

“When Wall Street sneezes, the world catches a cold” is an expression we all have heard. It has certainly proved true in the past. But when it comes to positive developments, why are we so slow to catch up with what is happening in the US?

Financial services history shows that we tend to be 10 years behind the US.

A few years ago, the concept of paying an exit fee rather than an initial charge for an investment product was relatively unheard of in the UK. Yet such products have been available in the US since the late 1980s and have grabbed market share dramatically.

A number of companies are beginning to offer such a share class on their UK Oeic range. In the US and Europe, the term adopted has been B shares. In the UK, Henderson has used the term X shares (X for exit fee).

If the example of the US is followed in the UK – and history would suggest this is a distinct possibility – then this share class could well become the vehicle of choice among investors. It is certainly something that advisers should have on their radar screens.

Our experience would suggest that the UK market is keen to embrace this charging structure. It is now a little over one year since we converted our unit trusts to Oeics. At the same time, we added the X-share structure to all Oeic sub-funds. Since then, we have seen sales of X shares outstrip sales of standard-charging A shares via our Isa offering. If we look at business coming in via Pep transfers, the shift to X shares is even more dramatic.

How does an exit charge work? The X share class adopts a simple charging structure. There is no initial charge for investments. Rather, a declining exit fee is charged over a set time period. For example, redemptions in the first six years of investment attract an exit charge declining annually from 4 per cent in the first and second years to 3 per cent, 2 per cent, 1 per cent and 1 per cent in the following four years.

The exact charging structure may vary between fund management groups but the principle is the same. Initial and annual commission arepaid to the adviser, typically at 3 per cent and 0.5 per cent. The annual management fee will be higher on X shares than the more traditional A shares.

Aha, I hear you cry, the catch is that the investor has to pay a higher annual management fee so they are not better off at all. Well, interestingly, this is not the stumbling block it might at first appear. The client is better off as there has been no initial charge paid so all their money is working for them from day one. This can have a dramatic impact on the returns expected.

Investors will typically be better off buying X shares rather than A shares for just over the first 10 years of investment. This is illustrated in the second table, which gives as an example a typical UK equity fund which has a 1.5 per cent annual management fee on the A shares and 2 per cent on the X shares. Initial and total expense ratios are also reflected.

While exit charging may not be appropriate for every individual, it does provide the consumer with flexibility and choice. It is here to stay and, if past US experience is a guide, to flourish.

RECENT HISTORY OF FINANCIAL SERVICES INNOVATIONS IN US AND UK

Early 1970s Unit-linking Early 1980s Unit-linking

Late 1970s Broker dealerships Late 1980s Networks

Early 1980s Tax incentives for Mid 1980s Peps

equity investments

Mid 1980s Derivative-backed Late 1990s Derivative-backed

investments investments

Mid 1990s Fund supermarkets Late 1990s Fund supermarkets

Early 1990s State 401(k) pensions 2001 Stakeholder pensions

Mid 1990s Multi-ties Early 2000s Same in UK?

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