Fund managers are experts at making money – for themselves that is! One reason that City bods get fat while their clients get thin is that fund managers get their hands on huge amounts of dough – literally billions. All they have to do is to find an excuse to slice off just a very small percentage. If you have ever wondered why jewellers and fine art dealers have addresses on Bond Street while bakers and ironmongers occupy the cheap streets, it is because you have to sell an awful lot of tin tacks or crusty rolls on a 10% margin to match the profit from selling a few old masters for a 5% margin. True, the latter may go for a week or two without making a single sale – but that is not a concern for City money managers who take their cut each and every day.
Another reason why the City is such a honeypot is that its denizens are very inventive – especially when it comes to thinking of ways to make themselves rich. The guiding principle of the City is ‘whatever the customers think they want, we’ll give it to them’. And what they are giving, today, to even supposedly sensible investors such as the BT Pension Scheme, are hedge funds.
RAB Capital is a fund manager that has jumped onto this bandwagon with spectacular success. I have been looking at its 2004 Annual Report. At the end of December it managed 12 funds totalling £1.1 billion, ranging from the £230m RAB Special Situations Fund to the £7m RAB Emerging Market Fund. Fund management is a pretty straightforward business, and management fees are essentially the only source of income.
So how much did RAB manage to carve off for itself last year? Well, first of all, enough to pay its wage bill of £19m – which works out at about £400,000 for each of its 48 employees. Then there were other administration costs of about £5m, and then there was the profit expected by RAB’s shareholders. Adding it all up, RAB generated total revenues of £36.1m last year from funds under its management, which started 2004 at £580m and rose to £1.1 billion.
So RAB managed to cream off about 4.6% of the year’s average of £780m entrusted to it by its clients. Of this, the RAB Special Situations Fund, which played the resources boom with great success, contributed fees of £15.5m, an astonishing 9.6% of its average value! True, much of this fee was contingent upon the good performance of the fund, although in days gone by fund managers did not expect such incentives to do their best.
RAB is now valued in the stock market at £250m, an extraordinarily high value that can only be justified if it can continue to call the markets right and earn those performance fees for years to come. I would say its chances of doing so are slim to zero.
Yet, amazingly, last month a group of investors including the Mittal family and Sofina, the finance arm of Belgian chemical group Solvay, swallowed this fantasy and bought 57.1m shares from RAB’s founders. One of these, Phillip Richards, justified the sale thus: ‘This transaction should be seen as part of the process of making RAB Capital into a more established and broad-based company.’ And not, of course, as ‘part of the process of making me extremely rich’.
There are now over 1,000 hedge funds in the United Kingdom. They all charge premium fees in return for promises of superior performance, and make the same sort of claims as RAB’s Annual Report, which talks about ‘high quality absolute return investment solutions’ created by ‘talented investment professionals working in a culture that is both creative and opportunistic’. Funny, though, how just about every hedge fund manager has crossed the fence from the staid world of institutional investment management, and has somehow become a genius simply by moving from one office to another.
Don’t be fooled by any of this. Hedge fund managers are not magicians who can conjure money out of thin air. The money that goes into their pocket comes straight out of the pocket of their customers. This is the City’s latest self-enrichment trick, and the good news is that by managing your own portfolio, and making your own investment decisions, you are not falling for it.
Tom Bulford is editor of Red Hot Penny Shares.
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