Money: Investments

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Europe is proving a dangerous place in which to try to invest. Hard on the heels of the Morgan Grenfell Scandal comes the final demise of Kleinwort Benson's European Privatisation Investment Trust, known as Kepit. The trust is going to be wound up, with - on the board's favoured proposal - shareholders having the chance to take either cash or units in either an M&G or a new European privatisation fund.

The Kepit saga is another cautionary tale for the times. As more details of the Morgan Grenfell disaster come out, it is clear that it is going to prove another example of one of the investment world's oldest truths - its performance was simply too good to be true. Investors could suspend disbelief as long as the exceptional performance persisted, but a reckoning with reality could not be deferred forever.

Kepit is a rather different - and perhaps more unusual - story. Far from being too good to be true, the trust has been too true to be any good. It will go down in history as the investment trust that proved too popular to do its job properly.

When it was launched just over two years ago, Kepit was one of the most successful launches ever seen in this country, raising pounds 500m. At the time, it seemed a terrific idea. With privatisation sweeping across every country in Europe, it was obvious that there were going to be a large number of new issues on offer.

As UK privatisation stocks have mostly been a great idea for investors so, the bright sparks at Kleinwort Benson reckoned, why not start a fund that invested solely in this kind of issue? As a marketing concept, it was brilliant. The punters certainly seemed to love it.

The pounds 500m raised was matched the next month by an almost identical offering from Mercury Asset Management. Its European Privatisation Investment Trust raised pounds 575m. Ten years earlier, any investment trust which raised pounds 25m would have been doing exceptionally well.

Alas, events were not as kind to Kepit as the concept seemed to merit. It didn't help that the launch coincided with the great bond market crash of February 1994, when it seemed as if interest rates were going to start rising sharply. Bond markets around the world took fright and stock markets shivered in sympathy.

But worse was to follow. Despite all the hoopla, Kepit simply refused to fly. Before too long the shares were trading at a substantial discount to the fund's net asset value, which itself was far from sparkling. The fund managers began to realise there were simply not enough good privatisation issues around to absorb the huge amounts of cash which they and Mercury had raised.

At one point the discount on Kepit's shares reached 20 per cent, when most other investment trusts were still trading at discounts below 10 per cent. The Mercury investment trust suffered a similar fate. Both trusts are still worth less today than the amount of money which the investors subscribed at the outset.

The poor performance of Kepit has become a major embarrassment for Kleinwort, which resorted to increasingly desperate attempts to breathe new life into it. To no avail. It didn't take a genius to work out that something would have to give. One of the great redeeming merits of the investment trust sector is that, unlike unit trusts, they are quoted companies - and trusts which perform badly are vulnerable to predatory action by more successful rivals.

As Kepit floundered, other fund management groups with an expertise in European markets naturally started casting their eye over it. Colin Maclean, whose Scottish Value Trust makes its living by investing in poorly performing investment trusts in order to put pressure on the managers, took a stake and started pressing for changes.

Then this summer, the dam burst. Henderson Touche Remnant launched a bid which offered shareholders the chance to swap their shares for a holding in TR European Growth, one of the most successful investment trusts in its field. Once their bid was on the table, the game was effectively up for Kepit. When the board met to decide its fate this month, it had nearly a dozen different options to consider.

This week it unveiled its advice to shareholders. It conceded that Kepit had no independent future, but rejected the TR bid. Instead, it is recommending a solution which will effectively give shareholders the chance to choose between taking cash for the value of the assets or switching their money into either a European unit trust run by M&G or a European privatisation unit trust run by - guess who? - Kleinwort Benson Investment Management.

The concept, says the chairman of Kepit, is still a valid one. European privatisations are here to stay, and there will be good profits to be made from them - one day. That may well be true. But it should not stop one drawing a few morals from the saga.

One is that fashionable concepts are never a substitute for careful investment. The concept itself overlooked several things, not least the fact that many of the privatisations in Europe have learnt lessons from the early UK experience and are rarely as generously priced as their UK counterparts. As the investment trust watchers at Credit Lyonnais Laing sagely pointed out two years ago "too many investment trust launches are led by marketing opportunities rather than on fundamental investment criteria".

Secondly, the Kepit saga rather gives the lie to the old notion that investment trusts are bought, while unit trusts are sold. Most people know that unit trusts are heavily influenced by commissions paid to intermediaries. It is no coincidence that the biggest selling unit trusts are usually the ones that have been most heavily promoted and pay the best commission rates.

It is probably no coincidence that Kepit was also the most heavily incentivised investment trust launch of all time. Kleinwort Benson paid a commission of 6 per cent to all those who submitted applications for shares - double the normal rate.

Now it says it rather wishes it hadn't - for the incentives, coupled with the way the concept caught fire, produced far more money than the fund could profitably invest. In economics, too much money chasing too few goods produces inflation: in investment trusts it just produces deflation and disappointment.

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