The Times, February 14, 2003

Reformer says funds would have been better off not trading

BY RICHARD MILES

PAUL MYNERS, former chief executive of Gartmore, last night launched an extraordinary attack on the investment management industry, claiming that most equity fund managers could produce better returns if they simply stopped dealing in shares.

Mr Myners, who called for sweeping reforms of the pension fund industry two years ago in a Treasury-sponsored report, urged investment managers to justify the £2.5 billion cost of actively trading UK equity portfolios each year.

“There is no evidence that this huge payment — a tax on investors — yields a positive return,” said Mr Myners, who as former head of Gartmore was in charge of one of the largest and most influential fund managers. He said nearly £1 billion of the trading costs was paid as commission to investment brokers. A further £700 million is thought to be paid in stamp duty to the Treasury, with the rest spent on custody fees and other expenses.

“But what if fund managers decided not to trade or to reduce trading significantly and increase portfolio concentration? I suspect the consequences would include enhanced risk-adjusted returns and significant advances in corporate governance as fund managers made fewer stock bets,” he told investment analysts at a dinner in the City last night.

He urged private investors and pension trustees to ask their fund managers how the portfolio would have performed had the manager done nothing, incurred no transaction costs, paid no stamp duty and absorbed none of the costs of “soft commission or other backhanders”. If fund managers and pension consultants refused to volunteer the information, then the regulator should force them to do so, said Mr Myners: “As a starting point the Financial Services Authority should require without delay that such analysis be reported henceforth to unit and investment trust holders.”

The FSA declined to comment on the content of the speech. The regulator is expected to publish its own proposals on soft and bundled commissions — the passing on of investment brokers’ expenses such as research — within the next month or two.

Mr Myners’s comments met with a mixed reception in the funds industry. Dick Saunders, chief executive of the Investment Management Association, said it was “entirely reasonable” for clients to ask fund managers the sort of questions that Mr Myners had raised. “A fund manager should be ready and able to justify his turnover of the portfolio,” said Mr Saunders. He bridled at the suggestion that a majority of UK equity managers could improve their performances simply by halting any active trading.

The Association of Investment Trust Companies said that it is already good practice for managers of closed-end funds to say in their annual reports how much stockpicking, asset allocation and other investment decisions had contributed to the total return.

Mr Myners first raised the issue of soft commissions and transaction costs in his review of the £800 billion pension fund industry for the Treasury in 2001. He recommended that fund managers’ contracts should include payments to cover research fees and broking commissions, rather than allowing the fund to absorb these costs. The Treasury said that unless the industry put its house in order it would intervene to force reform of soft commissions. Since then, the Investment Management Association has drawn up a voluntary code of conduct.

The Times February 14, 2003

Business Editor’s Commentary by Patience Wheatcroft

Fund managers found out

PAUL MYNERS knows all about fund management and now he has decided that much of it is a waste of money.

His conclusion that 60 per cent of fund managers would produce a better out-turn for clients if they avoided trading their portfolios will ensure that he is not the most popular man in the City.

Those who entrust their money into the care of the Square Mile’s finest should be horrified at the realisation of the transfer of value that is going from their funds into the pockets of fund managers who, all too often, do the wrong things with it and charge heavily for the disservice.

Myners, having made his own fortune in 17 years at Gartmore Investment Management, now speaks with all the zeal of the convert. Although he maintains that Gartmore’s performance was well above the norm, he has become increasingly sceptical about the level of fees that are charged in the City.

He made this clear when he delivered his report on institutional investment to the Chancellor of the Exchequer in 2001, but last night, at the Institutional Investor dinner, he went several steps further. The reception was not quite as hostile as that given to Eliot Spitzer at a similar occasion last autumn. The New York attorney- general told a gathering of analysts that he was delighted to be able to put faces to all the e-mails that he had been reading. Nevertheless, among the research teams gathered at the Dorchester, many already wondering whether their jobs would survive in the current climate, Myners’s words were hardly welcome.

But his case is undeniably strong. The costs of dealing are high, taking £2.5 billion a year out of UK equity portfolios. If that money is to be well spent, it demands that the stock that is bought far outperforms that which is sold. In a bull market, that is easier to achieve. In the conditions that have prevailed for the past three years, it is much tougher. And Myners reckons that equity markets are still over-valued, implying that investment decisions are not going to get any easier.

This is not an argument that fund managers are likely to put when they pitch for business. They have to justify their fees, part of which go to fund the analysts whose research may or may not be valued by investors. Myners has been a strong advocate of transparency on this matter, believing that the cost of research, as distinct from genuine dealing costs, should be made clear. Now he is going one step further.

His demand that the Financial Services Authority should require that unit and investment trust managers spell out how their funds would have performed had there been no trading would certainly focus minds. But it is the major pension fund investors who should also be seeking such information from their fund managers. Myners doubts that the information will be volunteered. Clients should start asking for it.

A key point in the Myners report was his call for pension fund trustees to take a more informed and involved attitude in investment decisions. He accepted that this would require a quantum change in the calibre of trustees. And as the news continues to flow of gaping pension fund deficits in leading companies, his conclusion seems all too correct.

Pension fund trustees have too often bowed meekly to the advice of consultants and fund managers and paid up when the bills came in. As a result, it is shareholders who now must carry the cost of bridging the funding gap. Investors in BT may today be wondering whether the pension fund trustees might have been able to do rather better had they encouraged their investment managers to do less. If Myners is right in his view that the equity market is still overvalued, the £1.5 billion gap is going to get wider.

Financial Times, Weekend 15/16 February 2003, page 4.

Fund managers pressed to reveal hidden costs

By Tony Tassell, Investment Correspondent

Fund managers are under pressure to reveal more of the hidden costs they pass on to investors. The Financial Services Authority, the market regulator, will shortly publish proposals to increase the transparency of such costs. Some analysts believe the move could spur fundamental changes in the way the fund management and stockbroking industries are structured.

The industries have been criticised for a lack of transparency in transaction costs passed by fund managers to investors. Over a long period, these costs can slash investors' returns by up to a half, some analysts believe. Critics argue that the structure has led to a poor deal for investors and may have inflated stockbroking revenues and subsidised the costs of fund managers.

"There is an absence of analysis of the true costs of trading that are passed on to investors," says Paul Myners, who led a government-sponsored review of institutional investment. He adds that there is reduced economic incentive for fund managers to reduce transaction costs if they are simply passed on. "It is like they are jockeys in a race, all carrying eight pounds of extra weight," he says.

The FSA is poised to publish consultation papers on three complex areas related to these costs.

The first two, expected over the next couple of months, will be on "soft commissions" and the "bundling" of fees for servlces supplied by stockbrokers - such as research and access to public offerings into one transaction cost.

Soft commissions are the practice of stockbrokers paying for services provided by third parties for fund managers in return for broking commission. This can include such things as specialist research and Bloomberg or Reuters trading screens.

Critics say bundling and soft commissions make it difficult to work out whether fund managers are getting the best value for the services they buy on behalf of clients from stockbrokers.

The third area of reform is ensuring stockbrokers trade in the most efficient way. The FSA has published a consultation paper and is now drawing up guidelines. It is unclear, how radical its proposals will be. It commissioned a review from Oxera, an Oxford-based economic consultancy, to consider the Impact of reforms. But at the least it is likely to increase disclosure requirements.

The industry has gone some way towards self-regulation to fend off restrictive new laws. Under a new code, fund managers will have to detail trading commissions, costs and volumes to pension funds.

Stockbrokers say there is little scope to reduce commission costs and if there were more direct charging for services, such as research, investors would end up paying more.. One fund manager said research was in effect supplied by stockbrokers for free as it represented marketing cross-subsidised by corporate finance activities.

However, Mr Myners says transaction costs need greater scrutiny. He estimates the cost of trading UK equity portfolios exceeds £2bn a year - of which almost £1bn is paid as agency commission to stockbrokers. "There is no evidence that this huge payment - a tax on investors - yields a positive return."

Mr Myners says that in an environment where equity market returns could fall to 6 or 7 per cent over the long term, transaction costs could. eat up half an investor's return from a unit trust over five years. This would eliminate any extra return the investor would get from taking the increased risk of buying equities over government bonds. Elkins - McShery, a consultancy, estimates pension funds spend an average 0.27 per cent of assets under management on transaction costs a year and they absorb a further 0.2 per cent on market impact costs. This compares with fund management service fees of 0.3 per cent and administration costs of running a scheme of 0.03 per cent.