And the winner is....

Probably not the consumer but is the balance tilting? 

I had the pleasure this month of attending the PLC Awards dinner at the Grosvenor House Hotel. The categories of award included Best Performing Share, Best Performing Smaller Company Fund, and Company of the Year. Funnily enough there was no award for most cost effective fundraising/acquisition of the year; that's possibly not something that the City would wish to celebrate.

Speaking to a wide range of people, there were many themes arising during the evening. A number of fund managers I spoke to cited fees paid to advisers by the companies they invest in as an issue for them in the coming year.  Although the dust has settled on the Kraft takeover of Cadbury, there still seems to be an ongoing disbelief that the phoney war masquerading as a takeover battle cost the companies a staggering US$450 million between them. There is a growing concern that some of the fee rates that increased in the good times have become the norm.

5% the Norm

Certainly, some years ago if you sought fee quotes for a fundraising you would get a range of quotes somewhere around 3 to 4 % depending on the amount to be raised. In the heady days of AIM those rates crept up to 5% and
seem to have stuck there and 5% is very much the norm if you talk to City brokers today. From what I hear that dynamic is repeated across the board in the bulge bracket firms of the type supporting Kraft and Cadbury in their
battle. Of course those fees are ultimately paid by you and me as the investors in the large pension and savings funds.

In the past, such fees have been fairly well hidden from investors. This is because they are usually added to the cost of the purchase in the balance sheet of the acquiring company and tend to get lost in the roundings of the acquisition value.

Accountants to the Rescue

However, assistance in making these costs more visible has come from an unlikely quarter. The great and good of the International Accounting Standards Board have recently revised that well known international financial reporting standard, IFRS 3 which sets the standard for accounting for business combinations (mergers and acquisitions to you and me). Most of the revisions are fairly unexciting as you d expect. However, tucked away in paragraph 53 is a change destined to create potential havoc to profit and loss accounts and perhaps also to advisers fees. Having spent many years creating accounting standards which most people regard as illogical and unhelpful, this could be the most useful thing the IASB has ever done.

The change requires that some of the costs of a transaction such as advisory, legal, accounting, valuation and other professional or consulting fees be charged through the profit and loss account. For many companies this may reduce their profits dramatically and for that reason companies will probably prefer to separate out these advisers costs into a separate line so that analysts and investors can see the underlying performance on a like-for-like basis: better clarity for analysts and investors, but also greater visibility of what advisers are being paid. This change came into effect for accounting periods from 1 July 2009, so in September 2010 the first companies to implement this new change will be reporting results. It will be interesting to see not just the impact it has on their profits but what impact it has on advisers fees and shareholder engagement by institutional investors.

The Big Fear

On top of that, City fees are under attack from another angle. There is only one thing that scares City folk more than not getting a decent bonus, and that s the fear of an effective regulator. So having gone through the bonus round over the last few weeks and suffered the ignominy of paltry bonuses, City folk are alarmed, to say the least, that the Office of Fair Trading is launching an investigation into investment banking fees. The City has learned to live with the FSA since its formation in 2000 and the FSA s performance during the credit crisis is summed up by the Conservative Party s commitment to abolish it if they form the next government.

The OFT, however, is another beast entirely. In March 2010, Philip Collins, the chairman of the competition watchdog, told a meeting of the Future of Banking Commission chaired by the Hon David Davis MP, that the OFT would be looking into investment banking fees later this year and investigate whether there is any cartel-type activity in that market. With some high profile cases under its belt and recognition for supporting the consumer against over charging, this should set some alarm bells ringing in the City.

City Guardians?

Meanwhile, back at the PLC Awards dinner, there was a bit of a cartel of opinion amongst a number of fund managers I spoke to, who all saw their role increasingly being one of shareholder engagement with one saying that he would not support any transactions by his companies where fees charged by advisers were too high. There s no doubt that the fund management industry has a role to play in moderating fee levels of advisers to companies they invest in, and it seems that many fund managers see a role for themselves as the guardians of the City in this respect.

Unfortunately, these comments were all made around the same time that Fidelity was promoting its new China Fund, to be run (for a few years anyway) by the legendary Anthony Bolton. There's no questioning Mr Bolton's track record but if anyone expects this fund to be a check against excessive fees by advisers then they should think again. In a remarkable demonstration that some parts of the City still haven't grasped the anger felt by the general public, this fund is going to charge investors not just an annual fee of 1.5% on the $1 billion of assets it will hold, but also a success fee of 15% of any outperformance in net asset value in excess of 2% above its benchmark, the MCSI Index.

Of course if the MCSI Index goes down, investors in the fund may end up losing some of the value of their holding. However, as long as it hasn't fallen by as much as the Index, the fund will take a success fee, despite investors holdings losing value.

This has had some private client brokers up in arms. The irony of this situation, of course, is that in many cases it's the very same firms of brokers (albeit their corporate finance departments) complaining about Fidelity's fees that active fund managers would target if they seek to reduce the fees paid by companies.
 
So, will the consumer be the ultimate winner in the battle of the fees? Probably not any time soon, but if the OFT applies its usual rigour to City fees then coupled with greater visibility of fees charged, there could be some tilting of the balance in favour of consumers in  coming years. But at the end of the day, nothing works like the market. So, as usual, if you don t like the fees that your companies or funds pay and charge, then the best thing to do is avoid them and move your money somewhere else.