Sky-high ambition

IT WAS interesting to read the other day that New Star, the fund management group founded by John Duffield, was a possibility for a stock market float later this year and would probably come with a price tag of £400m.

Granted that the whole point of leaking news of a possible flotation is to hype up the share price to silly levels and soften up those who are likely to buy the shares, this still seems rather a lot of money. Despite its high profile, New Star is a group with just £8.5bn under management.

It is, after all, less than a month since HHG, which is the public name of the Henderson fund management group, rearranged its affairs. The details of the transaction don't matter, but what is interesting is that a quarter of the company changed hands, and that put a grossed-up value on the whole HHG Invest fund management business of just under £500m.

This is more than New Star's potential valuation but HHG Invest is a vastly bigger business. It has £70.6bn of funds under management, broken down into life services funds £27.1bn, institutional funds £25.6bn, retail funds £11.1bn and others £8.8bn - and it has other non-fund management advisory activities as well.

Given that the profitability of fund management derives directly from the volume of money managed, either Henderson was dirt cheap or New Star is much too expensive.

Behaving badly

WHEN the Financial Services Authority fined Deutsche Morgan Grenfell last week for dealing in shares that the broker had guessed would soon be subject to a programme trade, the regulator had no doubt thought through what such activity might imply for the health of the market. It is taking rather longer for the implications to sink in elsewhere in the fund management industry and among pension consultants.

Morgan Grenfell was found to have disadvantaged its client by prehedging - buying shares in advance of receiving an order for those shares from a client. It might, perhaps, feel hard done by in being the first to be penalised for such an offence because pre-hedging seems to have been widespread practice among market-makers.

Morgan Grenfell's sin appears to have been one of excess - to have so overdone it that the price movement in one share, in particular Daily Mail and General Trust, was so great it was hard to overlook.

Morgan Grenfell repaid some money to the client to compensate for the adverse movement in prices caused by its actions. But given that the activity is widespread, there must be other programme trades where pre-hedging has taken place where the client has also been disadvantaged and where a similar case for compensation could be made. Perhaps the trustees of pension funds should ask their fund managers if they think they might have been taken advantage of in this way and if so, what if anything they propose to do about it.

The second point is one about market integrity. Fund managers choose firms to handle programme trades on the basis of a competitive tender. But if a brokerage firm intends to make substantial profits by prehedging, it can afford to undercut rivals that attempt to price the business fairly so they can make a profit without such clandestine dealing. The problem is that if the fund managers don't worry about what is going on because it is not their money, there is inadequate scrutiny of the process and the non-virtuous will succeed at the expense of those who try to treat the client fairly.

It also inhibits market developments such as crossing which would be good for the industry and save clients of fund managers the hundreds of miions of pounds that currently go to broker dealers in transaction costs. Networks such as E-Crossnet and ITG do such business without conflicts of interest and for much lower prices but the fund management industry has been disgracefully slow in making use of them.

The third point is that these are not trivial sums. Rival brokers who know what business is around and watch out for the appropriate price movements say it is not uncommon for firms to make £30m or more from programme trading when fund managers are rejigging portfolios. The brokers charge the fund two basis points (0.02%) for handling the deal but make 30 basis points more by the back door.

Despite pressure from the Treasury, the Myners Report and the Financial Services Authority, all of which is designed to expose this kind of practice and the costs it heaps on clients, fund managers continue to let the brokers get away with it.