Middle man fades away

EXECUTION ONLY: it sounds like the promise of a hangman with a conscience - hanging without the drawing and quartering. In fact, it is a curious piece of jargon in the financial services industry used to describe a particular way of buying and selling.

Some would argue that it eliminates the equivalent of drawing and quartering - being fleeced by an incompetent or sharp-dealing financial adviser. And the execution can be entirely positive, provided that customers know what they are doing and are aware of the hidden charges.

What does execution-only mean?

In its purest form, an execution-only or dealing-only transaction is one where you know exactly what you want to buy (or sell) and you ask a financial services firm to execute your instructions.

For example, you may have decided that you want to buy pounds 2,000 worth of ICI shares, or to invest pounds 5,000 in a Perpetual personal equity plan (PEP), or to put pounds 100 a month into a Standard Life personal pension.

You know exactly what you want and your instructions are carried out. The key point is that you are not getting any financial advice. The company is not required to find out all about your circumstances through what's called a "fact-to-find", which determines whether or not a particular investment product is suitable for you.

Sometimes, you may be asked to sign a form confirming that the basis of the transaction is execution-only, without any advice.

That's pure execution-only. What other forms can it take?

A lot of direct marketing of investment products results in an execution- only sale. In this case, you might respond to an advert in a newspaper or to a mailshot extolling the virtues of, say, a particular unit trust. If you respond to the advert and place an order, you may not get any further advice. If you don't, it's an execution-only transaction.

Isn't it best to get advice?

If you need advice, get it. If you are sure you don't need advice, an execution-only deal can be considerably cheaper - depending on where you buy the product.

Virgin Direct, for example, states clearly that it does not give any advice on its personal equity plans. This is one way it keeps costs down. Other "brand-name" companies, such as Marks & Spencer, don't give advice and don't offer particularly low costs. But Marks & Spencer is not doing anything different from any other company.

Where there's no cost advantage in buying direct, why not get some advice through a financial intermediary?

Some companies don't sell their products through intermediaries. However, the great majority do and it can be cheaper than going direct. Some stockbrokers, such as Fidelity and ShareLink, specialise in no-frills, low-cost share dealing.

Similarly, other intermediaries also concentrate on execution-only business. Two of the bigger firms are Chelsea Financial Services and Sheffield-based Garrison Investments. A third one, PEP Direct in Wolverhampton, has just come on to the market.

These firms sell a range of products and give advice to customers who want it. But they are discount brokers specialising in execution-only business.

How do discount brokers work?

They can give a discount by passing on some of their commission. It's the "pile it high, sell it cheap" principle. For example, if the firm gets 3 per cent commission, it might hold on to 1 per cent and pass 2 per cent on to you. In the case of PEP Direct, which can be reached on a freefone number, the cost is pounds 25 per transaction with the rest given back.

The discount may come in the form of a cheque or, more commonly, by having more of your money put into the chosen investment. If you go direct to the company running the investment you pay the full whack, and the company simply keeps the commission it would otherwise have paid to an adviser.

In fact, discount brokers annoy many product providers. They spend a small fortune advertising their wares at a certain price - and then a discount broker pops up with a tiny ad next to their expensive one, saying: "Go ahead and buy it. But it is much cheaper through my firm."

Note that other financial advisers, in addition to the specialist discount brokers, may also rebate part of their commission if you ask them.

But do you get no advice at all?

Before giving you advice, a financial adviser must find out all about your individual circumstances. This takes time. It involves the training of staff and compliance with regulatory procedures, which is also expensive.

Avoiding giving advice keeps down the costs. However, you can be given information, say, on how a particular investment has performed and what its prospects are. Remember, though, that execution-only intermediaries cannot say whether a particular product is suitable for you.

Nor can they give a recommendation between, for example, two different unit trusts. If an intermediary skews information in a way which is tantamount to a recommendation, this would constitute advice.

The regulatory authorities would take a dim view of this. The problem is that the borderline between information and advice is somewhat fuzzy. For example, some execution-only brokers will send a list of, say, 20 PEPs available through them. Some people may take it as a list of possible recommendations. The brokers will argue it is not.

Surely, there are some things for which advice is essential?

That depends on your point of view. Virgin Direct will be launching its own pension plans in the next few months and the company has decided that proper advice (in accordance with the regulations) will be available to those who want it at no extra cost. Marketing manager Tony Woods does not, though, believe advice should be compulsory. He sees it as the ultimate in the nanny state and condescension: many customers will know precisely what they want.

Apart from the lack of financial advice, is there any other disadvantage to an execution-only transaction?

There might be. You could lose a cooling-off period - in other words, a time when you can change your mind. If you are dealing on an execution- only basis, ask whether or not there is a cooling-off period and how long it lasts.

Anything else?

Beware of hidden costs. A one-off discount may sound attractive, but there are other charges. Roddy Kohn, at the Bristol-based independent financial advice firm Kohn Cougar, gives the following example.

Take a pounds 5,000 investment into a PEP. The execution-only broker says he will cut his commission from 3 per cent to just 1 per cent. This represents a saving to you of pounds 100.

But brokers also receive what is known as "renewal commission", which is usually set at 0.5 per cent for every year that you hold your PEP. Many execution-only brokers will do deals with providers whereby they get up to 0.75 per cent in renewal commission.

Taking the above example, if you stick with the PEP for four years - the minimum period recommended for share-related investments - you have given the broker his or her pounds 100 back anyway. After six years you are paying 50 per cent over the odds on your investment. Before you buy, ask what the renewal commission is. If the sums don't add up, find a reputable adviser; at least you are using his or her expertise for the same money.