Closet trackers are in the news again with today’s Telegraph reporting that the FCA may begin an enquiry, and campaigners accusing these fund providers of ‘fraud on an industrial scale.’
There are undoubtedly plenty of closet trackers out there, particularly in the pensions world. Investors in these funds would almost certainly be better off reviewing their holdings and moving their funds elsewhere. Usually they will be able to find a cheaper passive option which does a similar job, or a properly actively managed fund at a similar price. As a benchmark, Woodford Equity Income, an active fund run by one of the UK’s most talented managers, is available for an annual fund charge of between 0.6 percent and 0.75 percent. Legal & General UK Index fund (a tracker) is available for a fund charge of between 0.06 percent and 0.1 percent per annum.
Laith Khalaf, Senior Analyst, Hargreaves Lansdown:‘The prevalence of closet trackers in pensions is testament to an industry that has relied for too long on lacklustre default funds, and which has done little to help savers to make their own decisions. Now investors need to take matters into their own hands, and vote with their feet, if they are invested in a closet tracker fund. The best way to determine if you are in one of these funds is to look at a performance chart of your fund against its benchmark. If you can’t see much difference, chances are you are invested in a fund which isn’t adding much value, and you should consider switching to a cheaper index tracker, or a properly active fund.’
Our own research into pension funds tells us that closet tracking is fairly standard in the industry. But we are sceptical of claims fund managers running closet trackers have actually committed fraud. Many of these pension funds were set up and sold specifically on the basis that they would NOT deviate too far from the index. Indeed, if they were to start being very active, they would be in breach of their mandate. In our view the creation of the huge closet tracker industry in the pensions world can be summed up in two words- ‘default funds’. Company pension schemes, set up before the prominence of tracker funds, were faced with a decision on where to invest the pensions of thousands of default investors. They plumped for the least worst option, in their view: a fund with little chance of significant underperformance, in other words a closet tracker. This is gradually changing, with company pensions increasingly using pure passive funds as a default. Employers, advisers and providers are understandably moving on from these old-fashioned funds when it comes to new pension schemes.
However, tens of billions of pounds still remain invested in the old closet trackers, and millions of savers will end up abandoned in them too, unless they take action themselves. While investors should certainly review closet trackers, there is still some debate about what constitutes a closet tracker. Some commentators believe that closet trackers can be identified as those funds which have below 60 percent ‘active share.’ Active share is a measure we use in our fund analysis as a useful tool, in combination with others, to assess a manager’s investment style and performance.
However we believe it is potentially misleading if used in isolation to identify closet trackers, particularly with a 60 percent ceiling. For instance last week we issued an example of a hypothetical portfolio that had 56 percent active share, yet has outperformed the FTSE by more than 10 percent over the last 6 months. Let us know if you missed this and would like a copy. Active share isn’t a statistic which is generally available to fund investors, because it requires a fund’s full portfolio details to be able to calculate it. We would suggest investors can get a decent idea of how active their fund is by simply looking at a performance chart of the fund against its benchmark index, which can typically be found on the fund’s factsheet.
