Is Your Fund A Closet Tracker?

A report released yesterday brought to light the fact that many supposedly “active” funds are actually “closet trackers”. Perhaps I should first shed some light on the difference between the two.

An “active” fund is one where the fund manager is able to pick and choose the investments that make up the fund, normally constrained by some form of mandate, such as maintaining at least 50% of the fund in bonds, but this is not always the case. In an active fund the investor is hoping that the stock picking skills of the fund manager will lead to the fund outperforming its peers and the stock market index or benchmark which it is aligned to (the FTSE 100 would be an example).

In return for this stock picking skill and expertise, the fund manager will make a charge, usually a bit higher than the charge levied on so called “passive” or “tracker” funds.

In a passive fund the manager is simply trying to replicate the performance of an index or benchmark such as the FTSE 100. Because there is no active stock selection the charges on these funds tend to be lower.

What this new report highlights is that many supposedly active funds are actually very close to being a tracker, with little stock selection from the fund manager at all. The problem that this poses is that the investor will generally be paying a higher charge, but receiving the same performance as if they had invested in a tracker fund. In fact, the performance will usually be slightly worse, due to those very same higher charges.

Clients may want to review their investments to see what they are actually paying for. While we believe that there is a place for both active and passive funds in a clients portfolio, when recommending an active solution, we would always want to see that the fund manager is adding demonstrable value to justify the higher fee.

As part of our analysis of fund we will consider the amount of the fund actually being managed on an active basis. This will let us know if the fund manager is really generating additional performance, or whether the fund is actually a closet tracker with an unjustifiably high fee.