Drama becomes crisis for active fund managers

Railway solution; Opec misery
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The Independent Online

The spectacle of those responsible for investing our pension money slagging each other off in court has provided some splendid entertainment, but in terms of public relations it has also been little short of disastrous for an industry already under siege on all sides. We are now well into a second year of declining equity values, and even before all this started many pension fund trustees had begun to question whether "active" fund management is really worth the very high fees it commands.

The spectacle of those responsible for investing our pension money slagging each other off in court has provided some splendid entertainment, but in terms of public relations it has also been little short of disastrous for an industry already under siege on all sides. We are now well into a second year of declining equity values, and even before all this started many pension fund trustees had begun to question whether "active" fund management is really worth the very high fees it commands.

In theory, active management comes into its own during the bad times, since it actively managed funds ought to be able to beat the index trackers, which just follow the market down, simply by weighting heavily towards defensive stocks or by just staying out of equities altogether. In practice that's been very far from the norm, and even those who have beaten the market are getting little thanks for a performance which, however good against the benchmarks, is still likely to have been value destructive.

Now along comes Unilever versus Merrill Lynch further to shatter the industry's claim to be a responsible home for Britain's pension billions. Whether Unilever succeeds or not in its allegations of negligence, the case has left the impression of cavalier and shambolic unprofessionalism at the top. The client wasn't told the individual responsible for managing the money had been changed and Unilever has claimed procedures for addressing the underperformance problem were inadequate. It has also alleged inadequate discussion of the problem with trustees and, perhaps worst of all, that there was a disregard for agreed risk limitations.

The theatre of Court Room No 81 comes at a time when the industry is already under pressure on all sides. Costs and headcount are being slashed and fees are being squeezed. On top of everything else, fund managers are under instructions to implement the recommendations of the Myners report on the City, including an end to soft commissions, or risk a legislative clampdown.

If Unilever succeeds, the fund managers can expect a host of copycat cases. Trustees may feel obliged to sue if for no other reason than they may get sued themselves if they don't. Few chief executives have an easy relationship with the City grey suits who control their share capital, and many will jump at the opportunity to settle old scores. Carol Galley was herself famous for her unsentimental approach to chief executives and their companies. Many of her victims are still around.

Boardroom excess is the story that grabs the headlines, but it is completely eclipsed by the sort of money made in the City. Some fund managers earn more than the boardroom fat cats they all too frequently criticise and oust, and that for doing little more than keeping up with the index. Their recurring tendency to underperformance gives a whole new meaning to the expression reward for failure. Great pleasure will be taken in exposing such double standards.

More seriously, however, the likely consequences of an adverse ruling against Ms Galley and her team would be greatly to enhance the care taken in drawing up contracts between managers and pension funds. You cannot have your cake and eat it, Ms Galley and others have long claimed. To demand outperformance also involves accepting the risk of underperformance.

The highly restrictive contractual arrangements active fund managers are likely to insist on to safeguard themselves against litigation should this case succeed, may end up undermining active fund management altogether and driving everyone into passive indexing. It's not clear that this would be an entirely good thing.

Railway solution

This, alas, is what Stephen Byers did not tell Gwyneth Dunwoody's Commons Transport Select Committee yesterday. "Your Highness, members of the committee, representatives of the press, of whom I see there are a lot here present today. I have reflected on the decision I took five weeks ago to place Railtrack in administration and the representations I have received since and I can announce the following.

"The Government intends to bring forward legislation to take Railtrack back into full public ownership and compensate its shareholders accordingly. Despite being in the public sector, the company will pay private sector salaries and run at arms length from ministers. Train operating franchises will continue to be let to private sector firms and all enhancements of the network will be carried out by special purpose vehicles, a concept I am sure you are familiar with by now.

"I appreciate this will mean adding perhaps £10bn to the public finances. But no one can borrow more cheaply than the state. Furthermore, I would hope the measures announced today and the comfort I have given to the investment community will enable us to raise the additional £30bn in finance we still need from the private sector at lower cost."

What we got instead was the usual empty rhetoric about the need for a "a railway system fit for the 21st century" without the faintest hint about how this will be achieved. The railways need clear leadership. Instead what they have got is Mr Byers' ill-thought through plans for a company limited by guarantee. If a camel is a horse designed by committee, then this complex and cumbersome beast is the railway equivalent.

Mr Byers risks condemning the railways to a lengthy period of drift and decline where performance worsens and investment ceases. To break this cycle requires a Secretary of State for Transport with vision, stature and the strength to stand up to the Chancellor. Mr Byers is not that man.

Opec misery

Whenever Opec claims, as every now and again it does, to have cracked the oil price, you know it's all about to go horribly wrong once more. In recent years, Opec has been surprisingly successful in holding the price within its prescribed target range of $22 a barrel to $28, prompting the organisation to proclaim that the holy grail of price stability had finally been achieved.

Everytime it looked like breaking out of the range, Opec would simply turn up the tap, and when it got too low they'd turn it down again. It all seemed to be going so swimmingly and to be so much in everyone's best interests that Opec's disparate membership learned to obey the rules and stick to their quotas. And it might have continued to work, even with the present economic slowdown, but for the rogue card of Russia.

Since the Russian debt default, oil has been the country's only substantial source of hard currency, and as a consequence it's been producing more and more of the stuff regardless of Opec's attempts to match supply with demand. Yesterday it refused altogether to Opec's demands for cuts from non-Opec producers, prompting Opec to threaten not to go through with promised cuts of 1.5 million barrels a day either.

This is not ultimately a game Russia can win, since its costs of production are a lot higher than those of Saudi Arabia and most other Opec members. But it can do an awful lot of damage in the meantime, and Opec's avowed insistence that never again will the oil price be allowed to drop as low as $10 a barrel is beginning to look a little hollow.

j.warner@independent.co.uk

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