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Investment edge

Out of all the ideas that are thought up every day, some are crazier than others. Most disappear without a trace while some develop sufficient momentum to live a short while. Others acquire the necessary oxygen to merit attention. These become the items on our “to do” lists. They clog up our electronic mailboxes, tie us up in meetings and make the financial services industry what it is.

We all share a similar fate of having to address a welter of information borne out of endless change.

Praise the regulator which recognises that less prescriptive rules will help to counter the need for a major rewrite when new products are conceived. The new sourcebook for collective investment schemes was a while in the making – indeed, existing funds can continue to operate under the current version until February 2007 – but from April 2004 funds can be launched which adhere to the requirements of this much slimmer tome.

This time, when the FSA announced a consultation, it meant it. The industry has been provided with pretty well everything it asked for and the outcome of CP185 is a fine demonstration that the FSA has listened.

It has been known for salespeople occasionally to blame their falling sales levels on the absence of a product feature. Nevertheless, once provided, little changes. The salesperson has already identified the next missing item.

Business managers can do the same. Having acquired greater freedom in terms of property and non-retail investment schemes, there are some who have been choosing to look well past the new sourcebook, riveted by the dazzling allure of hedge funds.

Some hedge fund strategies may well squeeze within the boundaries of the new rules but most would not. The problem is that hedge funds are so very tempting. It is such lucrative work.

If a hedge fund can charge a 2 per cent fee and receive a further 20 per cent of its outperformance of a benchmark – and even a fund-of-hedge-funds manager can distil a 1.5 per cent fee and a 10 per cent share of the outperformance – that is heart-warming stuff to a business manager previously resigned to counting net revenue in terms of single-digit basis points.

But he has to do something soon. His best fund managers are leaving. Over recent years, there have been numerous defections from the world of mainstream fund management, so much so that the dynamics of the industry have been starting to shift. It is relatively easy to attract the best managers if you offer them a large slice of the returns they generate. They do not even need to run the risk of setting up their own businesses as there are plenty of established firms willing to offer them a position.

But surely clients will refuse to entertain such high fees and the lack of disclosure of these offshore funds will surely put them off. Not so. Formulaic rewards, albeit potentially very high, ally the interests of the client and the manager. Certainly, the BT and rail pension schemes have recently announced their intentions to invest £500m and £600m respectively in hedge funds and there are strong rumours that another 20 blue-chip pension funds are also considering allocating somewhere between 5 and 15 per cent of their portfolios to hedge funds. They want to make money no matter how equity markets perform – a highly attractive proposition in uncertain markets.

These products may not yet be available in the high street but if Saga is tying up with Rab to sell a range of absolute return funds, it cannot be so very far away.

Perhaps investors in more traditional funds are too apathetic to care but client retention will become a more important issue in the future if investors see better returns elsewhere – especially if they are being generated by the fund manager who used to look after their investments.

Now, about that idea of a regulated hedge fund for the retail investor…..

Anne McMeehan is director of Cauldron Consulting


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