First State has admitted that the large cap dominated MSCI AC Asia ex Japan index is "far from ideal" as a benchmark for its Scottish Oriental Smaller Companies trust’s performance fee.

Susie Rippingall’s £226m portfolio, which will be taken over by FE Alpha Manager Angus Tulloch next year, charges 10 per cent on top of anything upwards of the index plus 10 percentage points, based on the rolling three-year total return figure. 

A spokesperson for First State admitted the benchmark is far from a perfect fit given the small cap focus of the trust, but says the board has no viable alternative.  

"From inception in March 1995 until October 1999, the trust adopted the MSCI AC Asia ex Japan index as its benchmark, as no suitable regional smaller companies index was available at that time," the spokesperson said. 

"In October 1999 the directors agreed to the replacement of the MSCI with the SG Asian ex Japan Smaller Companies index, following its reconstitution to cover previously excluded countries. Unfortunately, this index ceased to be available from the end of 2002." 

"In 2003 the directors agreed to revert to the MSCI as the trust’s benchmark. This index, being dominated by larger companies, is far from ideal as a performance measurement tool. It has, however, the dual merit of being the most widely recognised regional index and of pre-dating the inception of the trust." 

On the trust’s monthly factsheet, it also uses the MSCI AC Asia ex Japan Small Cap index as a performance measure, but selects the larger cap index as its official performance-fee benchmark. When asked why First State does not use the smaller cap index, the spokesperson said: 

"This index is a relatively recent creation [compared to the trust] and isn’t as established as the main MSCI AC Asia ex Japan index." 

"The performance fee is based on three-year rolling periods which we believe in reality over the long-run will make little difference compared to a small cap index. Given that we start with a blank sheet of paper when we construct our portfolio, we feel any index will ultimately bear little resemblance to our portfolio."

As a result of the trust’s strong performance in the last three years – it is up 94.65 per cent compared with 26.82 per cent from its benchmark – the cost of owning the fund has increased significantly.

According to data from the AIC, Scottish Oriental Smaller Companies has seen its ongoing charges figure increase from 1.01 per cent to 2.28 per cent based on the last time the performance fee was charged. 

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Performance of trust vs indices over 3-yrs



Source: FE Analytics

The MSCI AC Asia ex Japan Small Cap index has actually returned less than the larger cap index over this period, but has consistently outperformed in rising markets since its inception in 2007. In 2009 it was up 89.59 per cent, while the MSCI AC Asia ex Japan index was up just 53.2 per cent.

Simon Elliott, analyst at investment trust specialist Winterflood Securities, agrees that the large cap focused benchmark is by no means the best performance measure.

However, he says the fact Rippingall has to beat a benchmark-plus figure over a rolling three-year period makes the situation a lot fairer for investors. 

"The benchmark index is not the perfect reflection of the fund’s investment universe; however, an additional hurdle of 10 percentage points is a tough hurdle in normal market conditions and does mitigate the mismatch somewhat," Elliott commented. 

"The fee is quite involved and has a number of unusual features, which could be taken as being positive for shareholders." 

"Its fee is capped at 5 per cent of the trust’s gross assets or its market cap, depending on what is the lower figure." 

Elliott says the complexity of First State’s fee structure shows how important it is for investors to know exactly what they have bought in to, but he does not think this controversy should be enough to put people off the Scottish Oriental Smaller Companies trust. 

"As I’ve said, it’s far from ideal, but I’ve seen a lot worse," he continued. "The famous case was about 12 years ago when the Henderson [Global] Technology trust used the MSCI World index as its performance fee benchmark during the dotcom bubble."

"It massively outperformed and paid out £45m or so in the way of a performance fee."

The Scottish Oriental Smaller Companies IT is currently trading on a discount of 2.8 per cent.

Performance of trust vs sector and index over 10-yrs

Name	1-yr returns (%)	3-yr returns (%)	5-yr returns (%)	10-yr returns (%)
Scottish Oriental Smaller Companies IT	21.88	94.65	129.91	617.21
MSCI AC Asia ex Japan	5.35	26.82	8.22	249.81
IT Asia Pacific ex Japan Equities	10	40.01	43.89	166.18

Source: FE Analytics

According to FE data, the trust has significantly outperformed its sector and benchmark over the short-, medium- and long-term. The only Asia Pacific trust that has managed to beat Scottish Oriental over three, five and 10 years is Hugh Young’s Aberdeen Asian Smaller Companies IT.  

The Aberdeen trust has an ongoing charge of 1.5 per cent, but does not have a performance fee. It is currently on a premium of 4.8 per cent.