Limit risk to win trust

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The Independent Online
Barely two months on, and the unit trust industry is still counting the cost of Morgan Grenfell's abject failure to control the activities of its aberrant fund manager, Peter Young. Most of the top guard at Morgan Grenfell's asset management business has now been removed by its parent, Deutsche Bank, but the knock-on impact on other fund management houses is still being felt. The chairman of one of Morgan Grenfell's biggest competitors told me this week that his sales of unit trusts virtually dried up altogether for two weeks in September. Such has been the damaging short-term impact of the Morgan Grenfell affair on investor confidence.

As so often happens with such scandals, the industry as a whole is paying for the sins of its most delinquent members. With the stable door hanging open, the regulators are pondering how best to stop the same kind of thing happening again. Forcing unit trusts to report quarterly instead of every six months is one idea that has been canvassed.

The spotlight is also once again falling on trustees, whose job it is to monitor that the manager of the XYZ fund is indeed investing in the way that it promised investors it would.

As in all such cases, nobody disputes the path which the industry needs to follow if it is to become more efficient and scandal-free. The answer can only lie in greater disclosure and clearer lines of accountability, coupled with harsh deterrents for those who wilfully or recklessly damage their investors' interests.

The Morgan Grenfell affair has highlighted how heavily - and potentially dangerously - power in the unit trust business is concentrated in the hands of the fund management companies.

They not only run and market the funds, but usually appoint the trustees and the auditors as well.

Unlike investment trusts, where there is - nominally at least - a board of directors to look out for shareholders' interests, the unitholder has, in practice, only limited protection from managers who abuse their power.

In a business where customers want the integrity of a Marks & Spencer, it is shameful how many grand City firms seem unable to prevent their names being tarnished by scandal.

The Morgan Grenfell affair has also underlined that the time for investors, trustees and financial advisers to ask questions is not just when a fund is doing exceptionally badly.

They also need to be alert when, like Morgan Grenfell's European Growth Fund, it has done exceptionally well. Sustained above-average performance almost invariably involves greater risk, though it may well not be apparent at first glance where that risk lies.

So more and better quality information would help. And don't think that it could not be provided easily. Last week, being in Edinburgh, I visited the people who know as much as anyone in this country about tracking fund managers' performance. The WM Company, a business that grew out of the old Wood Mackenzie stockbroking firm, is the market leader in monitoring, measuring and analysing performance for UK pension funds and life offices. It has also recently moved into the business of valuing unit trusts.

WM has vast data resources and several years of experience in tracking fund managers' performance. It is clear that there is no technical reason why they, or one of their competitors, could not produce regular portfolio reports on individual unit trust funds. By regular, I mean not just six monthly, but weekly or even daily, if required. These could easily be tailor-made to show not only how and where funds were investing, but also to highlight the risks - conscious or unconscious - that the fund managers were taking.

It is the kind of information that is already widely used by pension fund trustees and consultants. Such monitoring could quickly show how far any fund was (a) diverting from its own stated policy - eg investing in countries, currencies or sectors it was not meant to be; or (b) taking on additional risk by the way it chose to invest its funds.

For example, if a fund's objective was to achieve growth in UK equities, you could quickly see from how it split its portfolio whether it was making markedly different bets from the rest of those in that sector.

This kind of analysis would help investors to distinguish more clearly the kind of risk they were taking on by investing in a particular fund - and whether that risk was changing from quarter to quarter.

Several of the better companies, such as Flemings and MAM, helpfully already risk-rate the funds in their stable in broad terms (eg "high", "medium" or "low" risk). But this on its own may not always be enough. In a number of cases, as happened with the Barings collapse, it is clear that even those running large investment houses may not always know what kind of risks their employees are taking.

The big question, of course, about all this is not whether it could be done, but whether anyone can be persuaded to pay for such comprehensive monitoring. The fund managers, their trustees and their regulators clearly ought to have this kind of information as a matter of course. But should they supply it to IFAs and other advisers on demand? Would investors be prepared to pay for the cost of such a service on top of the hefty charges and management fees they already pay? These are all issues for debate.

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