When a group from the unit trust industry first approached the Treasury in the early 1990s to ask fo...
When a group from the unit trust industry first approached the Treasury in the early 1990s to ask for the new set of fund regulations - the regulations that ended as Oeics - the main justification was the fact it was impossible to export the old UK unit trust.
The reformers made a number of points. Unit trusts could only deal in one currency which was hopeless, of course, for the international investor who may have dollars or Deutschmarks in their bank accounts.
Funds based in Luxembourg or Dublin allowed managers to offer umbrella funds with a variety of share classes with different pricing structures to appeal to different types of investor, typically retail and institutional.
Unit trusts operated under Anglo Saxon trust law rather than company law, which made some major investors a little uneasy in case they ever had a legal dispute about a fund.
For bond funds (funds investing in fixed interest securities) the UK was ruled out because all distributions were paid net of UK income tax. In Dublin and Luxembourg such funds operated tax-free.
Finally, one of the biggest barriers to export was the UK dual pricing system with a 'bid offer spread' as well as a manager's charge. This was completely uncompetitive in markets where single prices were the norm.
Whereas all of the industry accepted most of these changes without demure, there was a long and tortuous debate about the merits of single pricing versus dual pricing.
On the face of it, the argument ran like this. In a single price system, a fund manager quotes a single net asset value which is the middle market price of the securities in a fund. Let's call that 100p per share. To this they add any initial management charge they choose to make, say 5%. This gives a price to buy of 105p and a price to sell of 100p. In a dual price system it works differently. When a fund manager gets cash coming in they have to go into the market and buy shares. This means they have to buy at the top of the market spread and pay stockbrokers' commission. Let's say these dealing costs amount to 1.5%. When they want to sell shares to meet redemptions they get a lower price and pays commission again. Let's call that another 1.5% in costs. A dual price system includes these costs and instead of calculating a single price of 100p calculates bid offer 98.5p and offer of 101.5p.
When the manager adds this initial charge on top of this spread, the customer is looking at a full spread of 98.5 to 106.5p - not an attractive comparison.
Although this looks like a bad deal, its proponents say that it is fair because it reflects the real cost of buying and selling shares when investors enter or leave a fund. In a single price system these are not allowed for. So, in a single price system people coming in to a fund pay too little and people leaving are paid too much and all the costs of this trading are paid by long-term holders who have their capital diluted by this process of paying short term holders costs.
Those seeking the change to Oeics argued that generally the amount of buying and selling an active fund manager undertakes in running a portfolio is much greater than the amount of the cash coming into or going out of a fund. So in fact the manager does not in practice have to make decisions different from those they would make anyway. The costs are illusory.
If a fund is relatively steady, with some investors selling shares back to the manager and some buying from them, those bid/offer spreads are, of course, a source of hidden extra profit to fund managers.
Single pricing decree
The Financial Services Authority (FSA) wrapped up the debate by decreeing that Oeics would be single priced, but, if a lot of money was flowing in and out of a fund, then the manager has the option to adjust the price by a dilution levy. The levy is always paid into the fund and cannot be touched by the manager.
With this final piece of the jigsaw in place, it was Threadneedle's belief that a UK Oeic was now a very competitive product overseas as well as at home.
First of all Threadneedle launched the UK's first true umbrella Oeic in August 1997, converting all its former unit trusts in one of the industry's largest ever fund conversions. But more than this, Threadneedle felt the same industrial logic would be true in Europe as well.
The UK Oeic offers pretty much the same sort of multi-fund umbrella structure as a Luxembourg Sicav. The Inland Revenue allowed gross share classes for bond funds to be sold to non-residents. Accordingly Threadneedle organised for the bulk of the assets in its Luxembourg Sicav to be moved into its Oeic in April 1998 and then closed down entirely its Luxembourg operation.
We believed the new structure could offer two particular benefits to European investors.
The first was low operating costs. All fund managers are increasingly subject to pressure on margins from clients and their advisers.
By moving all our funds in to a single structure and operating from a single site, we created considerable economies of scale. Running two product ranges, one for the UK and one for Europe, means much greater overheads from doubling up on client service systems, IT support, legal and compliance costs, fund accounting and so forth.
With a single fund range we were able to get our initial charges down to very competitive levels - 3.75% in the UK, while still paying full commission.
Moreover in Europe there is much greater scope than in the UK for fund managers to make hidden charges. These can take the form of 'administration charges' which are added on top of investment management fees, excessive foreign exchange rates being charged or from high custody or brokerage charges in those countries where the fund manager can contract this function to other companies in commercial group.
Of course, not all fund managers make use of these useful profit opportunities. But the temptation exists. For example, the
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