The forthcoming launch of Anthony Bolton’s Fidelity China Special Situations Fund is bothering me. I’ve written before about my concerns for the Chinese equity market, and that, clearly, is one big thing that would stop me handing over my own meagre savings to Fidelity.
But that isn’t really the problem – different opinions are what make a market, after all. The main problem is the cost of the fund. Take the management fee: at 1.5%, it is higher than the fee on the average investment trust. Assuming that Bolton brings in the $1bn he is after, it means that the fund will be immediately chucking out $15m a year in cash for its managers.
Then there is the performance fee: investors are to be charged 15% of any returns more than 2% over the returns made by the fund’s benchmark index – the MSCI China index.
The total performance fee won’t be more than 1.5% of the net asset value (NAV) every year (so another $15m on the $1bn that Bolton is trying to raise) and there will be a high-water mark – if the fund under-performs, a fee will not be paid until that is made up.
That all sounds fine. But it isn’t. Why? Because the words “under-performance” and “over-performance” cover up the fact that we are not talking about absolute returns here: everything is relative to the performance of the index.
So, if the MSCI China index falls 45% and Bolton’s fund falls 35%, Fidelity will still get another 1.5%. That might make sense to the financial industry but it simply doesn’t make any sense to me, and I suspect it won’t to most other ordinary investors either.
It is also worth pointing out that the performance fee is paid not with reference to the market capitalisation of the fund – i.e. the level of its share price – but to its net asset value. And one of the irritations of investment trusts is that their shares, for various reasons, very often trade at discounts to their net asset values.
Let’s go back to the example above, of the MSCI China index having fallen 45% and the NAV of the fund having fallen 35%. In an environment in which share prices are falling fast, there is a good chance that shares in all China investment trusts would start to trade at huge discounts (reflecting expectations that share prices would fall further).
So, while I gather that Fidelity intends to have some sort of mechanism to prevent too big a discount, it may be that the share price of this trust would fall 50%. The upshot? It could be possible for the share price to fall more than the MSCI China index but for investors to still be charged a performance fee. It’s an extreme example, but you get the point.
I’m not completely opposed to performance fees (although, just as with bankers’ bonuses, I’m at a loss to understand why people should be paid extra for doing well in a job we are already paying them to do as well as they can). But if they must exist, I can’t see why they can’t have targets attached to them that would really represent what an ordinary investor (not a fund manager) considers to be outperformance.
In my dream world – one where industries don’t exploit individuals – that would mean getting an extra fee only after beating the risk-free return on cash plus 5%, or beating the relevant index by 5%, depending on which level was the highest in any given year.
Setting a target at 2% over a benchmark that is as likely to fall as rise just isn’t good enough. After all, if we didn’t think an active fund manager could beat the market by a couple of percent, we wouldn’t bother paying his fees in the first place, would we?
Finally, as I have said here before, I am concerned by the fact that Fidelity is paying commissions to advisers who persuade their clients to put the fund into their ISAs. I don’t see why this is necessary, given that if any fund can stand alone on the merits of its manager, this one can.
Nor is it normal for investment trust managers to pay out commission. Note that the last big trust launches to do so were the Mercury European Privatisation Investment Trust and the Kleinwort European Privatisation Investment Trust in the 1990s. Both attracted vast amounts of money by paying high commissions to advisers at the top of the market. Both were disasters as investments.
I suspect it is beginning to look like I am picking on Anthony Bolton. I don’t mean to – I have the utmost respect for his investing record. It is just that this launch has reminded me of all that is wrong with our financial services industry. The fee structure of the fund has barely raised an eyebrow in the City, simply because these kinds of fees are pretty common.
But while they might not be unusual, they are still too lucrative for the fund managers for comfort – and that tells us something bad about the industry: the fees it charges are of such an unjustifiably high level that its existence often represents little more than a consistent transfer of wealth from savers to money managers.
• This article was first published in the Financial Times