InvestmentsJun 15 2015

Closet tracker funds appear to double to 17

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by

The number of ‘closet tracker’ funds – those funds that charge an active fee but appear to be closely aligned to a benchmark – has more than doubled in a year, new research by Investment Adviser shows.

In 2014, the number of potential closet tracker funds identified by our metric was just eight, but this year that has jumped to 17.

The Investment Association (IA) UK All Companies sector has the most closet trackers at 14, overtaking the North America sector which had housed the majority of closet tracker funds in the past two years.

Aberdeen Asset Management has one UK All Companies fund with tracker-like tendencies, the Swip MM UK Equity Growth fund, following its acquisition of Scottish Widows.

It is also the only fund manager with a potential closet tracker fund in the IA Global Emerging Markets sector. Aberdeen Emerging Markets has an R-squared of 0.98 and an active share of just 40 per cent.

A spokesperson for Aberdeen confirms the company is reviewing the positioning of all its funds in light of the Swip acquisition.

It states: “A number of mergers and fund changes are planned. These include adjustments to management fees for passive or quantitatively managed funds which are designed to track or closely follow a benchmark.”

JPMorgan Asset Management also has two potential closet tracker funds this year, having dropped out of last year’s list.

The JPM UK Managed Equity fund, run by James Illsley and Sarah Emly, has an active share of just 34 per cent and an R-squared of 0.97. JPMorgan insists the fund has always been run as a “core, low-risk” fund, which might explain why it has been in and out of the closet tracker list over the years. Meanwhile, the JPM UK Strategic Equity fund makes the list with an active share of 46 per cent and an R-squared of 0.97.

A spokesperson for JP Morgan notes: “At this moment, a number of the mega-cap names in the index are attractive investment opportunities for the fund given their cheap valuations. The fact we own a number of these names contributes to the lower than average active share. However, this is more a reflection of our size bias – driven by where we are finding value currently – than our levels of conviction.”

The £217.9m Axa General Trust, managed by Keith Robinson, dropped out of the closet tracker list in 2014, but makes a return in 2015.

A statement from Axa Investment Managers says: “The Axa General Trust is actively managed and takes active positions in individual stocks and sectors. It was established in 1969 to give equity exposure to a unit-linked insurance product.”

Two Santander UK All Companies funds have been flagged as potential tracker funds, having last been in the closet tracker research in 2012.

Santander Asset Management notes that both its UK Growth and PF UK Equity funds have had a manager change, with a subsequent change in holdings in both portfolios.

A spokesperson for Santander explains: “Graham Ashby joined the business to take over management of the funds on February 4 this year. Under Mr Ashby’s management, the funds have seen significant changes to their portfolios and transitioned from a large-cap bias to a mid-cap one.”

Santander points out that inherited holdings in FTSE 100 “index heavyweights” such as BP and GlaxoSmithKline have been sold, while new holdings have been established in mid caps including Berkeley Group and Savills.

The NFU Mutual Growth fund has not been identified as a closet tracker since 2012 but an active share of 41 per cent and an R-squared of 0.98 has seen it return as a potential tracker fund this year.

Paul Glover, chief investment manager at NFU Mutual, says: “The UK Growth fund has a mandate to outperform the FTSE All-Share over the long term. None of our funds are designed to be merely tracking an index and this has certainly not been our experience.”

He continues: “The fund aims to hold a significant portion in larger cap stocks and so will naturally have a commonality with the FTSE All-Share index.

“We decide how to allocate assets based on the qualities of the underlying investments and are transparent about our holdings, performance, charges and fees.”

A number of fund houses have come out recently in support of publishing active shares, promising to disclose the active share of all their funds.

BlackRock says: “We believe that active share data can be a useful tool as one of many risk metrics used to analyse and screen actively managed funds, but that it should not be viewed in isolation or be overly relied upon as a determinant of performance.”

Its BlackRock UK Equity fund appears as a potential closet tracker fund for the first time this year.

The IA North America sector has only two closet tracker funds this year, although the Legg Mason ClearBridge US Appreciation fund appears for the third consecutive year.

The Candriam Quant Equities USA fund is the only other North America fund to make the closet trackers list this year, although Bart Goosens, global head of quantitative equity management for the Candriam Quant Equities USA fund, disputes the findings.

He says: “A tracker or closet tracker fund tracks the benchmark and has, by consequence, a low level of turnover. The investment strategy applied to Candriam Quant Equities USA takes into account relevant changes concerning the companies in the investment universe on both short and long horizons.

“This implies that turnover applied to this fund is over 100 per cent per year. This is much higher than that of a tracker/closet tracker fund.”

Ellie Duncan is deputy features editor at Investment Adviser

The metric: How we worked it out

Using data from Morningstar, we looked at all the funds in the Investment Association UK All Companies, North America, Europe ex UK and Global Emerging Markets sectors to identify actively managed funds with annualised R-squared values of 0.95 or more for the three years to April 30 2015. This limit is based on the average R-squared value for all passive funds within the sector.

The annualised tracking error for the same period was added to show how closely aligned the funds have been to their respective benchmarks. The cut-off point was one percentage point lower than the highest tracking error of tracker funds in that IA sector.

The funds were then analysed using ‘active share’. In this report, portfolios with an active share of 60 per cent or less are considered to be potential closet trackers.

Investment Adviser compared the average performance of these funds with their benchmark indices and sector. Individual funds can outperform or underperform the figure for a variety of reasons such as stock selection, fees, cash holdings and manager changes.

The funds in the tables are sorted by sector, and it does not include any funds with the stated aim of tracking an index, or any institutional funds, although some may have an institutional bias. All companies on the list were given the opportunity to respond.

Closet trackers: Definitions

R-squared: A statistical measure that represents the percentage of a fund’s movements that are related to a benchmark index. In theory the more actively managed the fund, the lower the R-squared. Index trackers carry an R-squared value of 95-100 per cent.

Tracking error: The typical tracking error of an index tracker should be 0 per cent, but depending on the method of tracking it can be slightly higher, as any changes to the index need to be reflected in the fund by buying and selling appropriate stocks.

OCF: A fund’s ongoing charge, which has to be listed on a fund’s Kiid under Ucits rules.

Active share: This measures the share of a portfolio’s holdings that differs from the holdings in the benchmark. An active share of 100 per cent implies zero overlap with the benchmark.

Active share: Manager’s view

JPMorgan Asset Management states: “Our view is that active share can be a useful tool for judging funds, but is not a panacea. We know from our research that it is certainly a useful predicator of active risk, but it is less clear whether active share can predict outperformance.

“Put another way, we would say that a high active share is no guarantee a fund will outperform, as simply being different from the index is not enough to beat it. Evaluating funds based solely on active share and tracking error can lead to inaccurate conclusions with regards to ‘closet index’ funds.

“Instead, we feel active share and tracking error should be used as some of the tools in an investors’ due diligence toolbox, but not the only ones. From our perspective, these two tools should also be used in conjunction with other risk and return data such as information ratio and long-term performance versus benchmark and peers.”

Other potential closet trackers: What their managers say

There are several other funds that could fall into the category of closet trackers.

David Jones, head of financial adviser services, EMEA, at Dimensional Fund Advisors, has one potential closet tracker, the Dimensional UK Core Equity fund. He says: “The fund’s objective, like all our Core funds, is to offer exposure to the whole asset class.

“The fund holds the whole market, with a few specific and deliberate exceptions, and overweights small and value stocks, emphasising stocks with higher profitability.

“The process is very systematic, and neither active nor passive in the conventional sense.

“We take the best aspects of indexing and active management and merge them with robust, innovative implementation day to day. In doing so, we aim to beat benchmarks and the funds that track them.”

A Lloyds Banking Group spokesperson says the mandate for the Halifax UK Growth fund “reflects a style of fund management that we believe is appropriate to investing customers”.

“This uses a broad portfolio of stocks, which targets a consistent, modest level of outperformance, rather than a highly focused portfolio that may perform in a more volatile manner. The fund has outperformed its benchmark over three years, with performance consistent with that objective.”

Meanwhile Ivor Pether, manager of the Royal London UK Equity fund, notes: “The fund’s investors are mainly long-term life and pension clients, who are looking for general UK equity exposure.

“The fund is actively managed, with a requirement to generate ‘index plus’ returns on its investments without high risk, which is what the fund has achieved over the medium to long term.”

Adam Gent, head of UK sales at Legg Mason, denies the firm’s Legg Mason ClearBridge US Appreciation fund is a closet tracker.

“The Appreciation strategy was initially launched in the US in 1970 with a clear mandate to deliver competitive returns over a market cycle with 15-20 per cent less volatility than the S&P 500.

“The strategy has delivered these characteristics on a number of occasions. In 2008 the S&P 500 lost 37 per cent, while the fund was able to limit its capital loss to a 30.1 per cent decline. In 2009, while the S&P 500 rose 26.46 per cent, the fund was up by 19.2 per cent, thereby capturing more than 72 per cent of the upside... These are not the attributes of a closet index tracker.”