Contact: David Wilson, ext 7407

1 Introduction

1.1 The Fund's business plan, reviewed elsewhere on this agenda, stipulates that, as part of the Panel's role of ensuring that its managers are providing value for money, it should:

· Review the level of management fees paid in the previous 12 months to its managers in the autumn of each year

· Review the level of transaction costs, in particular brokerage and stamp duty, incurred in the previous 12 months, also in the autumn of each year

· Monitor the use of soft commission arrangements in each calendar year in the autumn of the following year.

1.2 This report:

· Reports fees paid to the managers in the year ended 30 September 2003

· Sets out the transaction costs chargeable to the Fund incurred by the managers in the year ended 30 September 2003

· Summarises the use of soft commission arrangements by the managers in 2002.

1 Managers' fees

1.1 Fees paid to the managers in the year ended 30 September 2003 are summarised in the table below:

1.2 Schroders remain by far the least expensive. Their role had been to act as an anchor for the Fund, and this was reflected in their previous less aggressive target of matching CAPS median performance. This was why their relatively modest fixed fee was agreed. They continue to charge this fixed fee despite their switch to a more active target of 1% outperformance of the benchmark from 1 July 2002. Flat fees are more advantageous for managers when portfolio values are falling. Despite the market falls during 2002, Schroders' fee percentage is still much lower those of the other managers.

1.3 Of the three main fund managers, SGAM charge the highest fee. This mainly reflects their relatively high first-tier charge of 0.35%. Their fee for portfolio values in excess of £300m was negotiated down from 0.25% to 0.2% when they were appointed.

1.4 It should be borne in mind that the achievement of good performance is the prime objective. The difference between the fees charged by Schroders and SGAM is equivalent to annual performance of just 0.16% a year. The difference between Deutsche and SGAM is much lower at only 0.05% a year. All three managers are working to a target of 1% outperformance net of fees.

1.5 Fees paid to Savills for the management of the property portfolio have more than doubled compared with the previous year. The main reason for this has been the charges made by Savills for working on the purchases of Banbury and Theale and the sale of the Nottingham retail warehouse development. Unlike the other managers, a large proportion of Savills' fees are based on their activity, like purchases, sales and rent review work. In part, these costs are the equivalent in the property market of the other managers' transaction costs considered in the next section. It should be borne in mind that, although management costs are high, the property portfolio has performed relatively well in recent years.

2 Transaction costs

2.1 Transaction costs are made up of:

· Explicit costs such as brokerage commission and, on purchases of UK equities, stamp duty.

· Implicit costs such as market impact - market impact includes the bid/offer spread (buying prices are higher than selling prices) and the effect of the size of market trades on prices obtained (for example, a large trade may drive up the price of a stock - this is because such trades cannot normally be settled in one deal and the first few purchases affect the price paid for later tranches). These are known as "execution costs".

2.2 Direct transaction costs like brokerage and stamp duty are easy to assess. However, execution costs are difficult to quantify. In last year's report it had been anticipated that a standard method of measuring these would have been agreed by now between the Investment Management Association (IMA) and National Association of Pension Funds (NAPF). However, this has not proved possible so far. Hence, the following table sets out only the direct costs incurred by the managers on transactions in the year ended 30 September 2003.

2.3 Schroders and Deutsche place considerable emphasis on the need to minimise trading costs. They actively manage their broker relationships and use their strong position in the market to make sure they receive first-class execution services at the most competitive commission rates. When appropriate they use programme trading to package transactions together, achieving savings through economies of scale. Since January 2003, Deutsche have made asset allocation adjustments using their Asset Allocation Fund. This has lowered transaction costs on their portfolio, as such costs are only payable on their stock selection activities.

2.4 SGAM's transaction costs are higher than the other two main managers. A major reason for this has been their relatively high level of UK equity transactions, where stamp duty at 0.5% is chargeable on purchases. Performance figures are calculated net of transaction costs, so if SGAM are to achieve their target they will need to recover these relatively high costs by higher performance returns. There is, therefore, a strong incentive for SGAM to minimise these costs within the context of achieving efficient and timely settlement of deals to capture performance gains. The County Treasurer will raise this issue with SGAM.

3 Soft commission in 2002

3.1 Soft commission occurs when brokers provide free research and other services to their clients, the fund managers. In return, fund managers agree to place a minimum level of business with those brokers. Any manager using soft commission arrangements emphasises that their main priority is to secure "best execution" for their clients and that this is never compromised. Soft commission normally means passing an invoice from a third party, for example fees for performance measurement, to the broker for payment.

3.2 None of the Fund's managers now uses soft commission arrangements. However, Deutsche was operating such arrangements during 2002. They ceased using soft commission early in 2003.

3.3 The table below gives details of the Deutsche's arrangements for 2002. The figures for 2001 are shown for comparison purposes.

3.4 The benefit, if any, to the Fund of a manager using soft commission arrangements should be lower management fees, although it is not possible to quantify the saving. The fact that all of the Fund's managers have decided to discontinue such arrangements, without asking for any increase in fee scales to compensate, suggests that any such benefit is minimal.

3.5 A list of disclosable soft commission services received by Deutsche in 2002 and a list of brokers with whom they had soft commission arrangements is provided in Appendix 1.

Recommendation

1 That this report be noted.

Section 100 D - Local Government Act 1972 - background papers

The following documents disclose facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of this report.

NB the list excludes:

1. Published works.

2. Documents which disclose exempt or confidential information as defined in the Act.

TITLE FILE

None.

Appendix 1

SOFT COMMISSION ARRANGEMENTS FOR 2002

This list relates to the "soft commission" services contracted to be used by the following operating companies of Deutsche Asset Management Group Limited (`DeAM') in the year ending 31 December 2002:-

Deutsche Asset Management Limited

Deutsche Asset Management Investment Services Limited

1) The Services received, internationally, by the DeAM Group Companies listed above are:-

a) Investment Research Services

b) Market and Corporate Data Services

c) Portfolio and Transactions Analysis, Performance Measurement and Attribution Analysis - Measurement and Software

2) The Broking Counterparties to the DeAM Companies' Soft Commission Arrangements for 2002 are:-

Credit Suisse First Boston Lehman Brothers International

Goldman Sachs International UBS Warburg