INTERACTIVE INVESTOR PROPOSITION REVIEW

The analysis – an overview  

In our last review we considered the new proposition from Hargreaves Lansdown; they are possibly the most well-known direct proposition in the market however they are not the only one. In 1995 Interactive Investor was created. They describe themselves as a trading platform for investors.

It is best to see their proposition as a kit car, they provide the investor with the tools to build their own portfolio but they will not steer the investor in any direction with regards to the final design.

What Interactive Investor did in 2012 was move to an unbundled structure ahead of others in the market, and although they were applauded by the media (Financial Times) they were met with criticism by some other direct propositions.

In this review we will unpick the proposition and highlight where it is positioned.

Bundled v unbundled – what does this mean?

A bundled fund has one annual charge, e.g. 1.5% p.a. It is collected by a fund manager but then this is split so part of the payment goes to Interactive Investor and part is retained by the investment house (fund manager).

In 2012 Interactive Investor moved to an unbundled structure so that the rebate payment that they were receiving was paid directly to the end investor. The quid pro quo was that they introduced a flat fee charging structure.

This put them in direct contrast to the market, which continued to offer what was perceived as a ‘free’ service.

What are the charges?  

The charges are very clear for an ISA and Investment Account. There is a flat fee of £20 per quarter.

To compare, Hargreaves Lansdown charges 0.45% p.a. so this means that on a fund of £20,000 Hargreaves Lansdown is charging £90 p.a. (slightly more expensive). As the value increases so does their charge. (Interactive Investor stays at £80 p.a.)  

However the are some additional points to consider which make the comparison slightly harder to understand:

1. Whereas Hargreaves Lansdown charges per account per client, Interactive Investor combines the charge for spouses and accounts. So for example, if a husband and wife have four accounts then the total charge is £20 per quarter for all accounts
2. Interactive Investor makes a charge for selling / buying shares and funds, whereas Hargreaves Lansdown only charges for shares. This means if an investor only holds funds Hargreaves Lansdown may be cheaper
3. For regular investors Interactive Investor charges £1.50 per trade. The £20 quarterly charge is held as a credit on the account and the trading charges for that quarter are offset against this
4. Any rebates for funds are paid back to the clients account

This is best described as follows:

1. Husband and wife have an ISA of £10,000 each and pay regular contributions of £100.00 per month into four funds each
2. The total charge is £20 per quarter, and they nominate the charge to come from the wife’s account. This is an equivalent charge of 0.4%
3. Each month the husband is charged £6.00 for each trade he makes, in total this comes to around £72 per year
4. Each month the wife is charged £6 for each trade she makes but this is offset against the £20 charge that is paid on the account. In effect this negates the trading charge 
5. This means in effect the total charge is around £152 a year compared to Hargreaves which would be £90. This means the breakeven point is around £35,000 of joint assets

Obviously this is an example but explains that care needs to be taken when comparing the charges, especially when trading more and using funds and shares.

Is there anything else you should know?

Interactive Investor charge £144 (including VAT) per client for a SIPP. However, the £20 quarterly fee for the ISA and personal account is waived. 

Any trading charges are in addition to this. 

Fees

Similar to Hargreaves Lansdown there must be sufficient cash to cover the quarterly charge of £20 (or £36 for the SIPP). Unlike Hargreaves Lansdown they will take this from the cash from regular payments on the account, and if not then from a debit card held on account. If there are insufficient funds to cover the charges then they will charge £25 which is significantly higher than Hargreaves. 

Can you move?

Yes but if an investor wants to keep their existing holdings (i.e. without selling them), Interactive Investor charges £15 per line of stock per account to transfer assets to a new provider for an ISA and Investment Account. If an investor has ten holdings they will have a charge of £150. 

For a pension the charge to move away is £120 (including VAT)

Does Interactive Investor offer good value?

For ISA and Investment Accounts with no regular investments and a value circa £20,000, Interactive Investor does appear to offer better value than Hargreaves Lansdown. If regular contributions are added into the mix then the breakeven point becomes much higher for Interactive Investor to be more cost effective. 

Where a pension is added into the mix; for a single person not paying contributions the breakeven point is around £30,000 to £35,000. For a couple it is around £60,000. For those paying regular contributions it becomes more complex. 

When using funds Interactive Investor fully rebates back any payment they receive and this could be around 0.64% (this is likely to be less than Hargreaves Lansdown who has greater buying power). 

If we consider Interactive Investor purely as a place to trade i.e. the kit car analogy, then at some points the proposition is cheaper and certainly for investors with larger sums to invest (£100,000 plus) it offers better value. What you don’t get with Interactive Investor are the bells and whistles you receive from Hargreaves Lansdown. Investors would need to consider whether the potential savings they make, compensate for the loss of benefits offered by Hargreaves Lansdown. 

So where now 

The ‘new’ Interactive Investor proposition has been in place for a couple of years and the platform has won a number of awards; certainly from an industry perspective it seems to have made the right moves. An investor will need to weigh up the cost against other platforms and decide what offers the best value to them, for what they want to do.

The investor needs to decide whether they want a kit car approach, where they are left to build the proposition at a fairly clear low cost base or whether they want a ready-made car which is likely to cost more. Interactive Investor believes there are sufficient savvy investors to go for the kit car version, and clearly being in the market since 1995 means they have a loyal following.

Our guess is that the majority will be comfortable with Hargreaves Lansdown as a respected brand offering a reasonable solution. Some Hargreaves Lansdown clients will undoubtedly pay significantly more when compared to the Interactive Investor model, but the problem persists in Financial Services; and that is that attempts to simplify choices for investors usually results in a plethora of new issues and choices for them to grapple with.

HARGREAVES LANSDOWN NEW PROPOSITION REVIEW

Make no mistake, Hargreaves Lansdown is to UK retail investing what Apple is too smart phones or Google to the internet, they are all enormous and dominant.

As we are based in Bristol we know them well and have observed a number of companies seek to challenge them, any are yet to succeed (and many have failed).

We suffer from no Hargreaves envy; they do what they do exceptionally well and have created a tremendous business. Their success has been aided by a number of factors which they were smart enough to recognise and maximise, in our view the three most important being.

1. They recognised the power and utility of the internet and created a first class web offering, over 50% of their business is transacted online and this is growing 
2.  They capitalised on the growing disillusionment with the financial services industry (endowments, with profit bonds, high commissions etc) to position themselves as offering client focused advice and great value in a treacherous environment for individuals (‘Honest Pete the Punters Pal’)
3. They benefited from the Government mandated reductions to initial commission which has moved financial planners away from clients with less than £100,000 of investable assets

However what we always knew was that many clients were under the impression Hargreaves didn’t charge them commission; of course this wasn’t the case, they did.

The funds they sold levied an annual charge to a client of up to 1.5% and the fund manager rebated (gave back) up to 1% of this to Hargreaves. Its true Hargreaves didn’t directly receive money from clients but the clients charges were Hargreaves income so it’s all in the telling.

Bundling (which is what this is called) is shortly going to be banned, the new rules require all fees charged to be explicit, so no longer can Hargreaves receive rebates. Clients will now know explicitly what Hargreaves are actually charging, because they legally have to tell them.

Over the last 18 months we have wondered whether many Hargreaves clients would feel slightly duped when it became clear that they had in fact been charged or whether they actually wouldn’t care.

We were also quizzical about how much Hargreaves would choose to explicitly charge. Some of the rebates they received on high volume funds were chunky, how would they match these as explicit fees and if they didn’t how much would their income reduce by?

We have written a detailed review of the new Hargreaves offering, we have no axe to grind, no horse in the race, we are just interested bystanders with enough knowledge to work through the detail to see what they are now doing.

See what you think.

The analysis – an overview  

For some time Hargreaves has been the champion of the direct investor community, and the darling of the city fuelling a meteoric rise in their share price.

It’s not hard to see why - they have slick systems, an excellent marketing communication machine and a dominant position in the market place. And for many investors there was a belief that the Hargreaves investment platform was effectively free and certainly they played on this.

Their new pricing structure has been eagerly awaited by many (well perhaps more the City and competitors rather than investors!), and in this report we want to unpack their new offering so investors can make informed decisions.

Bundled v unbundled – what does this mean?

A bundled fund has one annual charge, say 1.5% p.a., it is collected by a fund manager but then this is split so part of the payment goes to Hargreaves and part is retained by the investment house. The actual amount going to Hargreaves was not disclosed but is usually between 0.5% and 1% p.a. Hargreaves then gave part of that payment back to clients as a loyalty payment, typically around 0.15% p.a.

The problem with this approach was two-fold, firstly the end investor doesn’t know what Hargreaves are receiving and therefore cannot determine whether the payment reflects value for the service they receive and secondly there is always going to be a risk that there is a bias to promote funds which pay more money (we are not saying they do but there is always a doubt).

Unbundled funds (the new rules) strip all of that away. Hargreaves, or any other retailer, can no longer receive rebate payments. Their charge must now be visible so the end investor can judge whether it is fair, and because nobody can receive a kickback for promoting funds this removes any bias doubt.

What you will have with the new unbundled system is an investment house charge and a Hargreaves charge.

What are the new Hargreaves explicit charges?  

If you have OEIC funds only then the charges are pretty simple to understand. (The average investment per client according to the Hargreaves accounts is around £40,000).

Hargreaves will charge these clients 0.45% p.a. on the first £250,000, and then a lesser amount on a tiered basis for larger values

So on £40,000 the charge will be £180 p.a., and as the fund value increases so does the charge. We will look at other platforms in separate reports but to compare, iii.co.uk have a flat fee of £80 p.a.

But, the devil is in the detail.

1. The 0.45% p.a. charge is per account – so for example if the client had an ISA of £150,000 and a personal account of £150,000 they wouldn’t get the lower tier for having over £250,000, the ISA is 0.45% up to £250,000 and so is the personal account. Other direct providers take into account all assets held on the platform when calculating the charge and any discount
2. The second point is that for many direct providers not only do they take into account all assets held, they also take into account family accounts. So for example on iii.co.uk if the investor had £150,000 in an ISA and the same in the personal account, and the spouse had the same. The total charge would be £80 per year. For Hargreaves this would £2,700 per year
3. The third point is around the funds; effectively clients can transfer their assets to the new unbundled funds. When we spoke to Hargreaves they did indicate that for assets outside an ISA or SIPP this could potentially trigger a capital gains tax liability, so investors need to be careful when making this choice. (This will be the same for any provider moving from bundled to unbundled so is not a specific issue).

Clients can stay in the bundled funds and Hargreaves have confirmed they will no longer take any rebate, effectively this will come back to the investor as a loyalty payment. Investors need to be aware that for assets outside an ISA or SIPP this will trigger an income tax charge. 

Is there anything else you should know?

 Many clients use tracker or passive funds, these track an index such as the FTSE 100 or S&P 500. The advantage with these funds is that they are cheap. For example, a typical passive fund costs around 0.25% p.a., Hargreaves previously charged £1 or £2 p.m. for these holdings. The new charge is 0.45% p.a. – a typical investor with £40,000 invested with the £24 p.a. charge would have been paying 0.31% p.a., now they will be 0.70% p.a. In monetary terms this is an extra £156 p.a.

Fees

Moving to the new structure brings another complication; an investor now has to ensure they have sufficient cash in their account to pay the annual charge of 0.45%. 

If there is insufficient money in the cash account to pay the fee then Hargreaves will charge the investor £1.50 and sell down investments from the highest holding. Hargreaves has confirmed this charge will be taken monthly. So potentially failure to have sufficient cash will force a charge of £18 per year, per account. (Plus possible capital gains tax liabilities).

They have also introduced charges for paper based statements, the aim is to bring everything on-line which is cheaper for them to administer. 

Can you move?

Yes but if an investor wants to keep their existing holdings (an in-specie transfer). Hargreaves charge £25 per line of stock per account to transfer assets to a new provider. If an investor has ten holdings they will have a charge of £250 plus a closing account charge of £25. 

In addition if the investor just wants to move cash they will be charged £25 for closing the account and £25 for moving the cash. 

Do Hargreaves offer good value?

Hargreaves offer a number of benefits and this is where the investor needs to weigh up whether the cost is worth these benefits (which they can now more easily do with explicit charging). 

Over the coming months we will review other platforms, certainly at first glance for an ISA and personal account where investors can have fixed fees of £20 per quarter across all accounts as well as family accounts with other platforms they do seem expensive. On the pension side it is more complex and we will review this in a separate report. 

Hargreaves added value:

1.  Clients receive Investment Times – a magazine for clients highlighting investment ideas. As Hargreaves no longer have an incentive to promote funds offering higher rebates then this becomes more reliable. Investors may see this as value added research
2. Pricing power – Hargreaves are a dominant force in the direct to consumer market and are likely to be able to drive down costs, this no longer benefits Hargreaves but does benefit their investors. They have agreed significant charge reductions on 27 funds (out of a universe of 2000 plus) below the average charge (they confirmed) of around 0.65% p.a.

So where now 

For the average investor (for £50,000 of portfolio of assets on the platform) there is no substantive change in monetary terms, what has altered is the visibility of the charges.

Hargreaves has confirmed that these changes will cost them several million pounds and its unknown if this will have an impact on the service they currently provide. As investors the decision is really whether they value what they receive in terms of marketing information, the service proposition and the interface against what others may offer at a potentially cheaper price. 

For Hargreaves our guess is that they are confident that customers see their value and continue to invest with them, and with their dominant position they continue to attract new business. Certainly those holding their shares, frequently share this hope!   

High charges kill performance………

I have long argued that charges are not always the be all and end all when it comes to investing.

The problem is that we are fixated on charges and a belief that the higher the charges the more you will lose in your investments. To lower charges further there is an argument that funds which track an index will deliver better returns than an active fund because of the lower charges and the inability for many managers to beat the index.

For nearly five years we have been running portfolios, and recently I put together a closely matching portfolio tracking the index. The index takes into account a charge of around 0.4% and ours including the platform charge, fund charges and our fee comes in at around 1.7%. That is a whopping 1.3% p.a. difference.

Each year we review the funds and rebalance.

Our Cautious Portfolio has returned 84% since 1 January 2009; the equivalent index portfolio would have returned 43%.

On the more adventurous side the portfolio has delivered nearly 95% return and the index 57%.

This means on the cautious side we have delivered 95% out performance and 67% on the adventurous side with a 1.3% p.a. drag.

This blog is not about how good we are, the point of the blog is this. We are conditioned to think that high charges kill performance however good active managers will charge more as will financial planners however if they can deliver significant returns over the equivalent tracker portfolio then actually these high charges are insignificant.

Of course there are two additional points to consider, often when investors choose trackers they do not develop a portfolio of tracker funds and therefore heighten the risk and potentially lower the return and secondly investors can develop their own active portfolio. The cost of an equivalent active portfolio without advice would be around 1.35% p.a. The question then is, is it worth paying 0.35% p.a. to get someone to do the research and build the portfolios for you as well as giving you piece of mind with regards to your financial plans.

In conclusion what is painted is not always true you need to dig deeper, think deeper and sometimes go against the crowd to achieve what you want.