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.”
