Four common mistakes to avoid when picking a fund share class

Charges, income and currency hedging are important considerations for investors.  

Our goal on the content team at interactive investor is to make the hard topic of investing simpler by keeping customers up to date with the latest investment news, trends and strategy ideas.

One area where DIY investor can come undone is share classes, which are trickier to understand than they initially seem, with funds and exchange-traded funds (ETFs) offering a range of options for investors.

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Here is our guide to making sure your money ends up in the right version of your chosen fund.

Accumulation versus income

The biggest choice investors have, on almost every fund or ETF, is to select income or accumulation shares.

Income share classes pay any dividends or interest coupons from bonds into cash in an investor’s account, while accumulation units will reinvest income back into the fund itself.

For investors who want to spend the income their investments generate, or build up a cash pile, the income units are more suitable. For those who want their money to grow as much as possible over the long term and are still in the capital accumulation stage of their investment journey, then accumulation share classes are a better option.

Reinvesting income can make a large difference to returns. For example, the iShares Core FTSE 100 Ucits ETF has returned 155% since launch in May 2000 with income reinvested, but a 27% loss without any income reinvestment.

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Finding the cheapest share class

Type ‘Fundsmith Equity’ into the search bar on interactive investor and five share classes appear for Terry Smith’s highly rated fund.

Three are “income” and two are “accumulation”, and there are T, R, and I share classes available, meaning that the choice is not as simple as picking between an income and accumulation version.

R class shares cost 1.55%, T class shares cost 1.04% and I class shares cost 0.94%, so choosing the right one can save an investor a lot of money over a lifetime of investing.

Another big fund with different share classes is Fidelity Index World, a £4 billion global stock market tracker that regularly appears in our most-bought lists.

There are two accumulation shares classes, A and P. While P shares 0.12% in fees, A charges 0.3%, so picking the right one more than halves the fees paid.

So, why do different share classes exist for many popular funds? It is because share classes have specific purposes, but can still all find their way on to an investment platform.

In the case of Fundsmith Equity, the expensive R shares exist because, prior to rule changes introduced a decade ago, they were used by financial advisers and wealth managers, with the extra fees rebated to advisers and wealth managers in the form of commission payments.

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Since the beginning of 2013, fund managers have had to offer an 'unbundled' or 'clean' share class, which just comprises the fund management fee. Since that time advisers and wealth managers have had to charge investors an explicit fee for their services, with commission payments no longer allowed.

T class shares are what Terry Smith himself owns, and investors can own them directly via Fundsmith, instead of an investment platform.
I shares are the main retail share class, and therefore the cheapest and best option for DIY investors.

Investors should evaluate all share class on offer to make sure they invest in the cheapest one, and also read the literature from each share class to make sure that they understand what they are investing in and how much it will cost.  

Don’t go direct

Some fund managers allow investors to buy their funds directly, but although they do not charge a platform fee, their share classes are generally more expensive.

Fundsmith Equity offers T class shares for investors who want to buy directly, but these cost 1.04% compared with 0.94% for the main I retail share class.

M&G has its own investment platform, where it sells A share classes. However, these are more expensive than the R and I share classes that are available on platforms, such as interactive investor.

For example, its popular £2.1 billion M&G Global Dividend fund has I class shares costing 0.66% and A shares that cost 1.06%.

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Hedged or unhedged?

For fund investors wanting to mitigate currency risk, some overseas funds come in special versions that strip out changes in the exchange rate. These versions, called “hedged share classes”, have identical holdings and the same fund manager.

The difference is the currency hedging means that British investors will see the same percentage rise in their funds as local investors, with no reduction or benefit from currency swings. Such funds are not trying to call the market, the hedge simply aims to cut out currency exposure, good or bad.

Bear in mind, though, that hedging costs money, so annual charges on hedged share classes are typically 0.1 to 0.2 percentage points higher.

Analysis by interactive investor at the end of September of five funds that have hedged and unhedged share classes shows how much of a difference currency swings can make. Most striking is that over one year the unhedged share class of JPM US Equity Income is up 20.2% versus a loss of 4.1% for the hedged share class.

However, while in the past year UK investors with exposure to US shares have benefited from unhedged share classes, over one, three and five years, it has paid off to strip out Japanese currency exposure. The hedged share classes of Jupiter Japan Income, Lindsell Train Japanese Equity and Schroder Tokyo, show higher returns versus the unhedged share classes.