By CONRAD TAN

 

THERE is a lesson for investors from the recent $56.1 million net loss by CitySpring Infrastructure Trust - look closely at the fee structure of a new issue before you buy.

 

This is especially relevant now that there are more such vehicles listing here in the form of trusts or structured funds. Investors should look for those with fee structures that reward true effort and skill by the managers.

Future managers of such funds should also take note of the unhappiness of shareholders over the huge fees pocketed by CitySpring's management. There is no sound reason for rewarding managers with shareholders' money for the price increase on debut of a new listing.

CitySpring's net loss was due almost entirely to the unexpectedly large management fee of $63.4 million, of which $62.5 million was due to performance fees triggered by a sharp increase in its share price in the seven weeks from its Feb 12 listing.

The initial public offer may have been substantially underpriced - if so, the price surge on listing was due to investors paying what they saw as the fair value of the shares. But over such a short period, it is hard to see how the managers could have played a significant part in creating additional value for their shareholders.

CitySpring is not the only fund to have paid out so much to its managers for what some investors see as so little effort. Managers of the Macquarie International Infrastructure Fund (MIIF) earned $28.1 million in performance fees just five weeks after its listing on May 27, 2005. This was due almost entirely to a 16 per cent increase in its share price, from the listing date to June 30, 2005.

Solution

There are simple solutions to this problem. One is to exclude the share price performance on the first day of listing and base the performance fee calculation on the total return of the shares from the closing price on the first day, rather than the initial offer price.

Even better, waive the performance fee for the first two reporting periods. This would mean any increase in the share price immediately after the fund's listing - no matter how impressive - would not trigger a performance fee.

The earliest reward, if any, would be for share price appreciation that occurs over the quarter, half-year, or full-year - depending on how frequently the fee is assessed - that starts more than three months after the fund's listing.

This is in stark contrast to what happened with CitySpring and MIIF, and is arguably more palatable to shareholders. It is a lot more plausible that any outperformance of a benchmark by the share price three months or more after listing is due to sound investment decisions made by the management, rather than a sudden surge in demand for the fund's units.

A third alternative is to cap the fee at some reasonable level. The MacarthurCook Property Securities Fund, which was listed on Dec 22 last year, limits the performance fee, which is assessed yearly, to A$2 million (S$2.5 million) or 0.5 per cent of the fund value at the end of the financial year, whichever is lower. A similar cap would have prevented the performance fees ballooning out of all proportion to revenues in CitySpring's case.

Dilution

CitySpring's managers chose to pay themselves most of the management fee in shares, rather than cash. There are investors who think that a slight dilution of their stake is of little consequence, and that a bottomline net loss is unimportant, as long as the fund maintains its targeted cash distributions per unit.

This is a mistake.

It is true that in a business trust, as with similar investment vehicles, what matters most to shareholders is the amount of cash generated by its investments available for distribution, and CitySpring has said that it is on target to meet its per-unit distribution projections for the current financial year to next March-end.

But the 40 million new units issued to pay the bulk of the management fee have enlarged CitySpring's total share base, to 490 million units from 450 million, without any actual injection of new capital. Any cash that is distributed in future will have to be spread more thinly.

Put differently, the claims that all other shareholders have on the capital and future income of CitySpring have diminished by 8.2 per cent, as a result of the large management fee. The new units held by the managers rank equal with all other units and are entitled to their share of any future cash distributions - cash that could otherwise have been paid to other unitholders.

Potential investors in future funds that list here should look very closely at the fee structure of the fund, lest they be caught out again.