THERE is a curious logic being peddled around the fund management business at the moment - that investors in unit trusts and other schemes need not be told how much rebate fund management companies are receiving in brokerage commission on trades executed on investors' funds, but should instead concentrate on the performance of the fund in which they have invested. The rebate issue is, of course, twofold, for it concerns not simply rebates of commissions paid by brokerage houses to managers, but also rebates of up-front charges paid by managers to intermediaries. And it is against this background that Hong Kong's fund management business often wonders out loud why the sensible diversification available from a unit trust is not more popular with local investors. Just in case our investing gurus aren't smart enough to work it out, let's explore some of the answers. First of all, some fund managers rely heavily on rebates of brokerage commission in order to make a profit at all. This can mean that rebates are subsidising what are otherwise very thin management fees. It can also mean that business is being conducted inefficiently; and given that commissions rise and fall with trading volume, the prospect of rebates can mean thatmanagers are encouraged to churn or overtrade. Though buying and selling a portfolio four times in a year adds only modestly to the costs of managing, it will for most funds have a dramatic effect on the chances of beating the appropriate benchmark index. Secondly, there is a natural reluctance to pay up-front fees of as much as five per cent, particularly when some of this can find its way into the pocket of a paid adviser who, naturally, finds it in his interests to sell the fund in question. Frankly, if I'm paying my investment adviser for his service, I'm no happier at his enjoying a rebate of part of the up-front fees paid from funds in which he invests my money, any more than I would be for my doctor to be enjoying cash benefits from thedrug companies whose products he prescribes. If free diaries, lunches and air tickets are the thinner end of the wedge, cash in the pocket is what makes the wedge get well and truly stuck. Arguments have been advanced to the effect that because explanatory memoranda and trust deeds positively allow arrangements to share commissions, the situation is therefore not unfair to investors. But do fund investors really have any choice in the matter? Rather than paying for better performance, a heavier fee burden on the investor's money most often results in poorer, rather than better, performance. Anyone doubting the logic of this statement need only refer to studies of standard deviation to see how the vast majority of results (whether plotted from tossing a coin, managing investments, or this institute's examination results) are inevitably bunched closely together around the average. When investors expect the performance of funds to match or outperform an appropriate index, up-front fees, management charges and brokerage commissions together progressively wipe out the large number of performers whose results are bunched just above the average. The end result is that only a minority of money in the market manages to beat the index in any one year. To quote from the Economist, ''In only one of the past 10 years - reckons the performance assessing WM Company - has the average British pension fund's returns on British equities beaten the FT-A All-Share index, and that was before management fees.'' In other words, the pension fund would have done better simply to buy and hold the shares that make up the index. Micropal studies show that British unit trusts, which have much higher management fees, beat the index less than half the time even before deducting charges. So, when plotting the relative performance of cash in and cash out, the lesson, even for investors in a market as unashamedly inefficient as Hong Kong's, is to achieve your diversification for equity investments simply by buying the Hang Seng Index stocks direct and then leave well alone for several years. As survey after survey shows, almost every manager will have his day at some point during the cycle, but the chances of finding a manager today whose performance will still be beating the market in several years' time are slim, to say the least. As if running a long race against an Olympic gold medallist were not difficult enough already, it seems doubly strange that managers then choose to race not in sports shoes but in wellington boots. Would you willingly back Team Valour at Happy Valley (with or without Tony Cruz) if you knew he was starting with a five per cent weight handicap? But the argument about commission rebates need not stop there. For managers could give their investors a rather better chance of outperforming if the cost base of managing was reduced. Hong Kong, along with the rest of Southeast Asia and Japan, allows its stock market to decide the commission rates that are to be charged between member brokers and the investing public. This is indeed curious, for not only does none of this commission form part of the exchange's income, it is a policy which is the opposite to what is found in the exchanges of Europe, North America and Australasia - where the cost of trading in securities was lowered as a result of the deregulation seen over the past 20 years, and whose exchanges we might be expected to eclipse in the not-too-distant future. As much as our stock market exists for the purpose of allowing companies to raise new capital, its continued health is only assured by providing a secondary market for capital raised. That is the bringing together of willing buyers and willing sellers. In the buying and selling of securities there must be a commission rate at which a broker is prepared to deal and an investor prepared to buy or sell. A rate which will surely differ between a fund manager's sale of one million Cathay Pacific shares and my amah's purchase of 100. One which will leave all investors free to negotiate commission levels, and the price for the job will quickly be found - like it is in almost every other corner of Hong Kong's business world. John Brewer is a member of the Hong Kong Institute of Chartered Secretaries and Administrators.