Set apart from the rest of Europe, the UK has made a habit of doing things differently. And so it is with fund management; styles of management, types of product and legal structures are all quite distinct from their European counterparts. So why would a continental institution choose to invest in a UK fund? There are a number of good reasons why: not least because the UK is home to some of the most talented fund managers in the world.
Of course, the single characteristic that sets the UK apart from other European nations is the predominance of equity funds. The majority of the best UK market-oriented funds are found in the equity growth sector. The UK equity income sector has a few isolated examples of exceptional steady returns comparable with those of UK equity growth funds, but only two make the top 20, from ABN Amro and Jupiter (see table below). The top 20 general UK funds have shown good solid returns over various periods, but to put this into context, compare the performance of the top technology funds managed in the UK. These funds, from Aberdeen, Henderson and Scottish Equitable, have produced between 550% and 600% returns, compared with 280% for the top performing UK growth fund, from Jupiter.
Until two years ago, one of the main obstacles to foreign investment in UK funds was the unfamiliar structure of unit trusts, the traditional form of investment fund. The introduction of a new legal structure, the open end investment company (OEIC) – which conforms closely to the principles of the Sicav – has created the potential for greater use of UK funds. As pioneers of the cross-border marketing of UK OEICs, Threadneedle Investments has demonstrated that it is possible to sell UK-domiciled funds in overseas markets. The attractions, says group spokesman Richard Eats, are the simpler charging structure of the OEIC, which was one of the main reasons for the lack of foreign interest in unit trusts: “The reason foreign institutions don’t like unit trusts is the bid/offer spread, because it looks more expensive to deal, and in many cases it is.”
Eats says that institutional investors, which have been mainly insurance companies and fund of fund managers thus far, have tended to choose either UK funds or more specialist vehicles offering exposure to Japanese smaller companies or Latin America. Although institutional classes of share are made available on a number of UK OEICs, interest from foreign institutions has not been massive because of the more established alternatives for those seeking overseas or specialist exposure. Foreign investors looking at UK funds can find an offshore alternative to many of these funds, based in Luxembourg or Dublin. And where the management style is very similar, the performance of the funds will be good.
The UK can claim, with some justification, to be an attractive place to invest. It has a very tax-efficient environment for investment funds in terms of the double taxation relief agreements with other countries. There is no tax on the funds outside the UK and no stamp duty. From April last year, the system of advanced corporation tax was abolished, which made fund accounting a very much simpler affair. The effect was felt most keenly by unit trusts and OEICs invested in overseas equities, which suffered the tax in the past, but with it now out of the way, are far more attractive. One further change brought in by the most recent UK budget allows for gross income payment on bond funds, which is tied in with the exchange of information measures relating to the Europe-wide withholding tax proposals. This has obvious attractions for international investors.
So with the relative neutrality of its tax regime, the UK is fast becoming a credible rival to the European offshore centres. New regulations are being introduced to add to this message. Sheila Nicholl at the UK fund trade association Autif confirms that UK fund promoters tend to be clearer and fairer in their charging methods than continental counterparts: “The level of competition and disclosure by UK fund managers makes the UK funds market very competitive.” She points out that while rival fund domiciles like Luxembourg and Dublin would claim to be more flexible in terms of accommodating new ideas, the UK is narrowing the gap. She cites the new moves to expand the scope of open-ended investment companies in the Financial Services and Markets Act. This gives more scope to the UK regulator, the Financial Services Authority. If, for example, there was a move to include mixed funds (direct equities and other funds) under the OEIC structure, rather than having to introduce secondary legislation, the FSA will now have the power to rule on such issues. This will encourage innovation and with the decoupling of OEICs II legislation from the endless process of Ucits II, this new and more Euro-friendly fund structure is expected to accommodate all categories of fund currently available within the unit trust format.
However, the moves to make the UK more attractive to foreign investors is not reflected in foreign purchase of unit trusts and OEICs. Historically, gross sales of UK unit trusts to institutions have been less than 10% of the total annual sales, which for 1999 were around the £200bn (E318bn) mark. The introduction of OEICS has had some effect in accelerating this trend, but internationally, the market is not expected to grow substantially because so many of the best known fund names have similar products available in Luxembourg and Dublin.
The top 20 UK funds, taking in key sectors such as UK equity and equity income, tend to reflect the change in ownership of fund groups and the move away from the undeniably British groups that dominated the UK funds market in the 1980s and early 1990s. Although the largest fund managers, in terms of assets, in the UK are essentially Anglo-Saxon – M&G, Schroders, Perpetual, Fidelity and Barclays – names like ABN Amro and Dresdner RCM, Legg Mason and Sanwa now feature at the top of the performance league tables. This reflects London’s position as a major financial centre, but equally the value of UK fund management talent to global institutions.
Reliance on past performance is being discredited by consultants such as Bacon & Woodrow, and with some justification. There is no substitute for independent and detailed analysis of the current strategy of an investment fund. Jupiter is a classic example of this. The group’s investment performance across a range of funds has been exceptional for some time. But the recent departure of its chief executive and a handful of key fund managers places a large question mark over the continued success of the company. Brokers have already begun advising their clients to switch out, in anticipation of a tail-off in performance. And make no mistake, while investment process is important, it is the individual manager who makes the difference between an average fund and an exceptional one.
It is a manager’s ability to combine additional alpha return with a high level of risk control and attribution analysis that makes an investment in a UK-managed fund such an attractive proposition.
Richard Newell is a director of Croydon-based Forsyth Partners, which offers fund of funds portfolios; http://www.