Brace yourselves. I am going to tell you a bit about how investment companies work. Then, I am going to tell you about two that haven’t worked quite as one would have liked recently. Finally, I will tell you how we can solve most of the problems of the financial industry with one simple step.
I write about investment companies a lot, but mainly from the point of view of the things that they are invested in. However, the key point to note on them is that they are companies, not just funds. It just so happens that their main business is not making widgets, but investing money. As companies, they have a board of directors, which employs a fund manager or a firm of fund managers to manage the shareholders’ money.
The directors are not there to protect the interests of the manager. They are there to make sure that the manager performs as well as possible within the constraints of active fund management and to protect the interests of their shareholders. When you buy shares in an investment company, you put your faith in the directors to do just this. (I should point out here that I am a non-executive director of two investment trusts.)
Irritatingly, boards don’t always behave in a way that justifies that faith. Take International Public Partnerships. To quote Canaccord Genuity’s Alan Brierley, who has recently changed his rating on the fund to ‘sell’, this firm has “a management contract that time forgot”. Lots of other investment companies have slashed fees, dumped performance fees and improved transparency over the past few years. This one has not.
It has what I regard as a horrible performance fee. It isn’t properly benchmarked; it doesn’t have a high-water mark (so you could end up paying for the same performance many times over); it isn’t capped; and it is structured so that it can be paid out even if the fund underperforms. It also comes with some other extras.
Think of paying a fund manager as being a bit like paying school fees: you hand over what looks like a fortune, and then they come back demanding lunch money. If this fund makes an acquisition, for example, its investors get to pay an extra fee on it of 1.5%. The other big infrastructure funds – such as HICL Infrastructure and John Laing Infrastructure – need lunch money too, but rather less (1% and 0.75% respectively).
This is all pretty indefensible. The good news is that the directors know that, so they have proposed a new system for the shareholders to vote on. The managers will give up the performance fee and slightly cut the management fees. The bad news is that the directors clearly feel that the management needs to get something in return for giving up these ludicrous fees.
So, assuming the deal gets voted through, they intend to extend the management contract to 15 years (HICL has a contract that can be terminated with one year’s notice). At the same time, they want to remove a ‘key man’ clause from the contract (the old contract could be cancelled if two of three key men step down). Doesn’t sound like a big deal? It is.
Imagine getting a contract that gave you 1% or so of a couple of hundred million for 15 years without even obliging you to stick around. The directors are clear that “there is no current suggestion of any change in the investment adviser’s senior management”. But with a deal like that, I’d certainly be tempted to sell up and head for Monaco.
I could bore you with more details, but the key point is this: the directors have, as Brierley points out, provided two bad options for their shareholders and they aren’t going to win any prizes for transparency either. This is exactly the kind of thing that breeds the lack of trust that is slowly killing the relationship between the financial industry and the rest of us. Retail investors are increasingly convinced that the industry exists solely to rip them off. That isn’t entirely true, but you can certainly see why one might wonder.
Now on to the next one, the Midas Growth and Income Trust. I had a letter from a reader complaining about the company’s behaviour at its annual meeting. Trusts are companies, so shareholders can vote to wind them up and get their money out. This doesn’t happen often, but last week some of Midas’s shareholders decided they wanted out. So they voted against the firm continuing. They lost: 51.89% of those who voted did so for continuation. But here’s the rub: the vote was carried because the fund manager – who holds shares in Midas in another fund he runs – cast his vote for continuation.
I’ve spoken to the manager. He cast his vote before it was obvious there was discontent in the ranks. I don’t think we can count this as particularly bad behaviour and no one has done anything technically wrong at all. However, I don’t see why companies should have crossholdings among their funds. Midas itself owns a good many other funds in its portfolio, so to have another fund holding it is effectively to have a fund holding a fund that holds funds. Which is just silly. And if they must hold these shares, should managers be able to vote for continuation given the obvious vested interest?
In an atmosphere of trust, all this would probably have passed unnoticed. Instead, my reader’s immediate instinct was to assume a rip-off or conspiracy of some kind. This matters. Most of us don’t want to spend our time worrying about how much our banks and our fund managers are taking from us and what ruse they’re going to come up with next. We just want to trust them to take a fair and transparent fee and leave us to get on with our own stuff. And of course, they want us to trust them too.
The manager of the Midas trust doesn’t want me ringing with irritating questions on a Thursday afternoon. He wants to get on with running money. Trust makes everyone’s lives so much easier. So what’s the one step the industry can take to bring it back? It is simple really. All they have to do is be trustworthy. Make things transparent, clear, simple and fair – and trust will gradually be rebuilt.
• This article was first published in the Financial Times.