Outing closet trackers

The number of ‘benchmark hugging’ funds – or closet trackers – is on the increase, Investment Adviser’s third annual Mid-Year Monitor reveals.

In 2010, Investment Adviser devised a metric using Morningstar data and identified 19 potential closet trackers in the IMA UK All Companies sector. In 2011, this dropped by just one to 18 funds, including products from big names such as Henderson Global Investors, Santander Asset Management and Standard Life Investments.

Last year also saw the report extended to include the IMA North America, Global Emerging Markets and Europe excluding UK sectors, uncovering a further two offenders in the first of these sectors.

This year, however, has seen the number of closet trackers in the IMA UK All Companies sector leap to 24. Investment Adviser has also discovered that nine funds exist within the IMA Global Emerging Markets sector with high R-Squared values and low tracking errors, metrics which indicate less divergence from the funds’ benchmark.

In-depth detail on how the metric works is given on the page opposite, but, simply put, it is based on funds with an annualised tracking error of less than 4.55 and an R-Squared value (see definitions) of 95 per cent and above. The list of those affected includes heavyweight houses such as Aberdeen Asset Management, Franklin Templeton and JPMorgan Asset Management.

To throw additional weight behind the research in this year’s report, the potential closet trackers have been further analysed using a measure referred to as ‘active share’.

Devised by Martijn Cremers and Antti Petajisto of the Yale School of Management, this measures the share of the portfolio holdings that differ from the holdings in a fund’s benchmark index.

An active share of 100 per cent implies zero overlap with the benchmark. Index funds have an active share of zero per cent. For the purpose of this report, an active share below 60 per cent is classed as a closet tracker.

Starting with the IMA UK All Companies sector, the most tracker-like fund in this year’s list is the £268.6m NFU UK Growth fund, managed by Nigel Yates, with a tracking error of 1.65, an R-Squared value of 99.43 per cent and an active share totalling just 24.14 per cent.

In spite of carrying a total expense ratio (TER) of 1.52 per cent, the fund failed to outperform the FTSE All-Share over five years to May 9. In fact, it lost its investors 1.33 per cent, while the index gained 1.36 per cent.

Over a three-year period, the product did only marginally better than the index, returning 40.97 per cent, compared with a return for the index of 39.91 per cent to May 9.

In the fund manager’s absence, NFU Mutual’s chief investment manager Paul Glover explains: “The NFU Mutual Investment team manage in excess of £12bn across a mixture of in-house and retail funds and asset classes. All of the funds are challenged with outperforming their respective benchmarks (index or peer group as appropriate) over a long-term period. None of our funds are designed to be merely tracking an index and this has certainly not been our experience.