By analysing a group of UK equity funds with a three-year track record, research house Fundscape and consultancy gbi2 found that 11% were true trackers, 7% were concentrated stock pickers and 50% were diversified stock pickers, with about 32% deserving to be branded closet trackers.
The analysis was conducted as part of the annual ‘Gatekeepers’ report – Unlocking the secrets of fund research’.
This year’s report looked at 48 gatekeepers up from 36 last year including D2C buy-lists, adviser buy-lists, ratings agencies and DFMs which control about 70% of the asset management market representing gross sales of £94bn.
It also found that those funds recommended by the gatekeepers tended to show an active share of about 70% and lower ongoing charge figures (OCFs), suggesting gatekeepers were not generally promoting closet trackers.
The analysis determined funds’ active share plotted against their three-year tracking error using 60% as the minimum requirement for a fund to be considered active.
Methodology
Much of its methodology for the analysis was from a landmark study by Martijn Cremers and Antti Petajisto at Yale University in 2006 which looked at 2,650 funds between 1980 and 2003. This found that funds with an active share of 80% or higher, beat their benchmark indices by 2-2.71% before fees and by 1.49-1.59% after fees.
The analysis of UK equity funds from the UK All Companies and UK Equity Income sectors found about one third of UK funds had very low tracking errors and low active shares, denoting closet trackers.
The report says: “We found that index trackers are where you would expect them to be — active share in single figures and a low tracking error (below 4%). These accounted for around 11% of the funds in our list.
“At the high end of the active share scale, focused funds that hold only a small number of stocks i.e. using concentrated stock-picking, had an above average tracking error as one might expect representing around 7% of the sample.”
It also found a group of funds which had high active share, but low-to -average tracking error. “These funds tended to have significantly larger numbers of stocks in the fund; they were broadly diversified while still exhibiting high selectivity accounting for half the funds in the sample,” the report says.
“However, we also found funds exhibiting very low tracking error with low active share, clearly priced as active funds, but behaving very much like the index. ‘Closet trackers’ as these funds have come to be described, accounted for around a third of UK equity funds. These funds are overpriced and misleading investors.”
The report suggests that FCA efforts should be concentrated on funds in this segment.
“On the subject of active management performance, the regulator has tarred too many fund managers with the same brush. There is a significant minority of funds that are charging for active management without delivering it. It is these offenders who need to be challenged on their prices.
“Collectively these closet trackers ‘average down’ the quality of active management and should be subject to a deeper investigation by the FCA.”
