The main principle of the Growth+ Funds is to grow your investment whilst avoiding the ‘boom and bust’ of stock markets. This is achieved by mixing different asset classes, such as stocks, bonds, property and hedge funds, that perform in different, and usually staggered cycles. Selecting from a very broad range of underlying managers, operating in quite different fields, avoids the concentration risk’ of having too much exposure to any one company, country or management method.
The Clarion Growth+ Funds incorporate our best growth ideas, selecting collective investment schemes that have an emphasis on high returns, typically in equities. They are therefore more subject to market movement and investors should have an expectation that the unit price will be volatile. The return expectation is also higher than the other Clarion funds, with a net performance target in excess of 5% over the three-month deposit rate.
The main principle of the Growth+ Funds is to grow your investment whilst avoiding the ‘boom and bust’ of stock markets. This is achieved by mixing different asset classes, such as stocks, bonds, property and hedge funds, that perform in different, and usually staggered cycles. Selecting from a very broad range of underlying managers, operating in quite different fields, avoids the concentration risk’ of having too much exposure to any one company, country or management method. We value original thinking, due diligence and first-hand research. With 1,838 staff in 23 countries, our mission is to deliver superior asset performance and exemplary client service, through consistent active management processes across diverse asset classes.
Higher tax for you, higher profits for your fund manager
Imagine for a moment you’re a funds manager. You work for a large firm running a fund which is paid a base management fee, say 1 per cent of funds under management, plus an “outperformance fee”, which is paid if you deliver returns better than a set benchmark.
Your job seems simple enough. Apart from the fact that you don’t suffer proportionally when the fund falls, there’s a broad “alignment of interests” between you and your investors.
So you pick stocks and allocate the portfolio to achieve the highest possible returns. Everyone’s happy.
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Except one day you’re faced with a dilemma. Do you maximise your fund’s reported performance (and hence your employer’s fees) or maximise the actual after-tax returns many of your investors will receive?
Funds managers tend not to talk openly about this issue, which is why I’m going to use the example of a business I’m associated with, run by someone who is frank about these conflicts, to illustrate the problem.
But every funds manager, whether they admit it or not, faces this dilemma. And the incentives suggest that the fund manager, in many cases, is likely to preference their fees (and career) over your returns.
Steve Johnson, chief investment officer of Intelligent Investor Funds Management, in Tax matters: Tell your fund manager, says that;
“Post-tax performance reporting by fund managers has been mandatory in the US since 2001 but here in Australia, it is optional, and most fund managers choose the easy option of reporting only pre-tax returns. Because what gets measured gets done, your fund manager’s focus is on pre-tax outcomes.”
Johnson currently faces a real-life example of this quandary, which nicely illustrates the nature of the problem.
Some 10 per cent of the fund he runs is invested in RHG shares, purchased at an average price of $0.58. Johnson can sell on market for about $1.00 per share, or tender into the company’s upcoming buyback and receive $0.88 in cash, comprising a fully franked dividend of $0.70, an unfranked dividend of $0.17 and a capital return of $0.01.
On a pre-tax basis, $1.00 is obviously better than $0.88 and the extra 12 cents would add in excess of 1 per cent to the fund’s pre-tax performance this year.
That’s a meaningful number (and one that would help him beat his benchmark and potentially achieve a performance fee).
“But,” he says, “were I to sell those shares on market, whilst my fund and the performance it achieves would benefit, many of my investors would be worse off.”
The accompanying table, which sets out the post-tax returns for investors on different tax rates under the two scenarios, shows how (it assumes the tax office allows the fund to use the capital loss, a matter on which it hasn’t yet ruled).
Tax rates
Except those on the top marginal rate, every investor is substantially better off if the fund sells into the buyback. For a super fund with a tax rate of zero, the difference equates to about 2 per cent of their investment in the fund, a return not to be lightly dismissed.
Now put yourself back in the seat of our fictitious fund manager. You want to do the right thing for your investors but you also know that doing so comes at a cost. That cost has three components.
Firstly, selling into the buyback at $0.88 rather than on-market at $1.00 diminishes your pre-tax performance.
That’s a worry because you know that managed fund investors place a heavy emphasis on pre-tax returns (they’re the numbers potential investors will see published in the paper when comparing the hundreds of alternatives they have).
You want to do everything in your power to get this number up because it’s the biggest factor in determining future funds under management; typically the biggest driver of a fund manager’s revenues.
Secondly, selling into the buyback could be the difference between achieving an outperformance fee and not (based on the pre-tax return).
And finally, if you sell into the buyback you’ll suffer lower funds under management than if you sell on market because the law forces funds to pay out any income received as well as realised capital gains each year.
The conflicts are rife and the incentives arranged in such a way as to place the fund manager at odds with their investors in cases such as this.
It’s a big problem. Everyone with an indirect interest in a managed fund is affected. So if part of your superannuation is invested in a managed fund, you’ll be impacted.
How could it be fixed? “The first step is to get your fund to report post-tax returns at least once a year,” says Johnson. “It’s not straight forward and the results can be very different for investors on different tax rates. But it’s not that hard to produce a table assessing a range of scenarios for a fund’s annual results.” Indeed, fund managers like Vanguard and Dimensional should be applauded for doing exactly that.
But these examples are exceptions. Fund managers are likely to fight tooth and nail to avoid this requirement. The status quo is comparatively convenient for them. Right now, in effect, you may be paying more in tax while delivering higher fees to those managing your investments.
If this trillion-dollar industry can’t resolve this iniquity by itself, I’d say there’s a strong case for it being legally required to do so. It works in the US. Why not here?
This article contains general investment advice only (under AFSL 282288).
Greg Hoffman is research director of The Intelligent Investor. BusinessDay readers can enjoy a free trial offer at The Intelligent Investor website. For more Intelligent Investor articles Old Broad Street Research has withdrawn its A rating for the Baring Emerging Markets fund and removed it from the service following recent manager changes.
The move was prompted by the announced departure of managers James Syme and Paul Wymborne.
Roberto Lampl, current head of Latin America equities, is set to take over management of the fund becoming head of global emerging market equities.
The rating service said it would meet with the new fund manager in the coming months to discuss his plans.
Lampl will be supported by Mark Julio. Syme and Wymborne will stay on 'to ensure a smooth transition process' before joining JO Hambro Capital Management, according to Baring. An additional person is set to be recruited onto its Latin American team.
Syme and Wimborne have been recruited ahead of the launch of a new emerging markets fund for JO Hambro later in 2011.
By Simon Gray - No-one is ready to say that the good times have returned for London’s hedge fund industry, but professionals say the sector is definitely on the mend after the traumas of the past three years, when a near-across the board slump in performance and a resulting wave of investor redemptions sent the industry worldwide assets plunging by at least 30 per cent (possibly more) from peak to trough. Today the trend remains resolutely in the other direction.
Although up to date statistics are lacking and in some respects verge on the anecdotal, and the recent trend toward firms setting up operations in multiple jurisdictions makes calculation even harder, there is little reason to believe that there has been any substantial shift since 2009, when London accounted for around two-thirds of European hedge fund management firms and an estimated 75 to 90 per cent of their total assets under management, according to promotional body TheCityUK and its predecessor, International Financial Services London.
The optimism is qualified, though. What is taken as a clear sign of the industry’s returning health, the number of new funds being launched and of start-up managers entering the market, has to be weighed against the evident difficulties managers, especially newcomers with little or no independent track record, are encountering in trying to raise capital, although firms with an established infrastructure that got through the downturn without infuriating their client base with redemption restriction seem to be faring better.
This is at a time when the increased transparency being demanded by investors, especially institutions, is adding to costs in areas such as compliance, risk management and reporting, and when regulatory changes are promising more of the same. And maddeningly, the downturn seems to have done little to tame the often-daunting costs inherent in using London as a base from which to do business.
“We found that rental prices were still very high when we moved office a year ago,” says Simon Dinning, London managing partner of offshore legal specialist Ogier. “Things seem to have gone full circle in recruitment, too. The reality is that it’s an employee’s market now. A lot of people were laid off, but things are picking up and firms need to recruit. Good managers are in a much stronger position than they were 18 months ago.”
“We found that rental prices were still very high when we moved office a year ago,” says Simon Dinning, London managing partner of offshore legal specialist Ogier. “Things seem to have recovered and indeed gone full circle in recruitment. The reality is that in the legal field it is an employee’s market now. Unfortunately some firms did have to let a number of people go, but things are picking up and firms are hiring again.”
He recognises that these trends reflect the rebound in business confidence in recent months. “We had a very busy end to last year, not just in funds but notably in equity capital markets transactions. This activity appears to be continuing in 2011. While I don't believe anyone is predicting an exceptional year, there is certainly a degree of confidence returning.”
According to Dinning, fund launches are taking place with, on average, smaller amounts of capital being raised than would have been the case three or four years ago, but even then there are exceptions. “There are still some decent-sized launches taking place involving established managers with a track record and perhaps access to a larger pool of capital,” he says. “But it may take all of this year and perhaps some of next year before some of the new start-ups really begin to raise significant pools of capital.”
Recovery from the market turbulence of 2008-09 may not yet be in full throttle but an improvement in the business environment is clear, according to Julian Korek (pictured), founding member of consultants Kinetic Partners. “What is noticeable is that funds that enjoy investor confidence have fared particularly well,” he says. “For example, there are new flows into funds that investors feel have good governance plus performance. In addition, there is a pattern of the larger funds getting bigger, which reinforces the view that larger managers with better infrastructure and governance are seen as better places to invest.”
He also notes the tougher environment for start-ups. “The influx of new managers into the market is picking up, but capital-raising for new funds is proving difficult unless the manager has come out of an environment where they are taking a fund with them,” Korek says. “For managers starting from scratch it is still an uphill struggle, but we expect an upturn in the establishment of new funds in 2011. Of particular importance is the significant number of prop teams leaving large banks and setting up on their own, often with bank support.”
Getting the right infrastructure in place is essential if these managers are to inspire confidence among investing institutions, according to Chris Cattermole, sales manager for Advent Software’s Geneva system for Europe, the Middle East and Africa. “A lot of managers spinning out of investment banks are used to having all the tools at their fingertips,” he says. “All of a sudden they need to think about building a business rather than just trading.”
The founders of start-up firms need more than just the technology, though. “They need to have someone who understands the industry as their de facto chief operating officer,” Cattermole says. “They have to keep abreast of all regulatory requirements, the requirements of the new EU alternative fund managers directive or the Ucits requirements if that’s relevant. In small firms there is often one person wearing multiple hats as the chief operating officer, chief financial officer and compliance officer. The need for such a person is often overlooked until the business starts to gain traction.”
Martin Cornish, an investment management partner at law firm K&L Gates, says the industry is probably benefiting from a lifting of some of the uncertainty that has surrounded it over the past couple of years, not only because of ongoing volatility in the markets, fears over the solvency of certain European issuers of sovereign debt and the risk of a ‘double-dip’ economic recession, but also the long-running soap opera of the European Union’s Alternative Investment Fund Managers Directive.
“It was beginning to clear by the third quarter of last year, but up to then there was so much uncertainty about regulation, tax and jobs that you’d have been a brave man to set up during that period,” he says. “Some probably did it out of necessity, but it wasn’t the ideal time, and money-raising was – and continues to be – a real issue.