Nearly half of UK equity funds are closet tracking the FTSE All Share index as part of a “scandalous index cloning epidemic”, according to a new report from SCM Private.
The study, from the firm behind the True and Fair campaign for transparency in the investment management industry, found that a substantial proportion of funds charged higher fees than tracker funds but didn’t differ significantly from the index.
The firm used research from H K.J Martijn Cremers and Antti Petajisto at Yale University that defined a closet index tracking fund as one that has an active share position of 60 per cent or less.
Active share is defined as the fraction of a portfolio or fund that is invested differently from its benchmark, in this case the FTSE All Share index.
The research covered 127 retail UK equity funds, managing a combined £120bn in assets.
JPMorgan Asset Management had several funds defined as “closet trackers”, with both the JPM UK Higher Income and the JPM UK Strategic Equity Income funds having an active share measure of less than 45 per cent.
The JPM UK Equity fund had an active share of 38.4 per cent but has recently been merged into the JPM UK Strategic Growth fund, while the JPM UK Dynamic fund had an active share value of 54.2 per cent.
A spokesperson for JPMAM said the UK Higher Income fund had been restructured three years ago, since when it had outperformed the FTSE All Share index.
The spokesperson said: “The way we manage funds across our UK equity range, they may not always have the highest active share versus the benchmark.
“However, over most periods except this exact five-year one, the three funds that appear in the SCM report – UK Higher Income, UK Strategic Equity Income and UK Dynamic – have outperformed the index net of fees, demonstrating that we have added value for our clients even though we are not taking big bets against the index.
“By comparison, an investor in a fund that accurately tracks an index will always underperform the index net of fees.”
A Scottish Widows spokesperson said the UK Growth and UK Equity Income were “both actively managed and are not passive tracker funds”.
“The Scottish Widows UK Growth fund is managed to a strategy that involves a broad range of stocks, rather than a small number of large positions,” the spokesperson said.
“Inevitably this management style produces a greater overlap with the index. The fund is actively managed and aims to outperform a tracker.”
The spokesperson added the UK Equity Income fund had a boas towards income generating stocks.
Other major houses with funds that had an active share value of less than 50 per cent included M&G and BlackRock.
In June this year, Investment Adviser’s annual research had found that there were only nine potential closet tracking funds throughout all the IMA sectors, defined by having three-year annualised tracking error of less than 4.55 per cent, an R-squared value of 95 per cent or more and an active share of 60 per cent or less.
The SCM research found that closet tracking was far more common in the UK than in the US, as it analysed 227 US equity funds benchmarked against the S&P 500 and found that only 10 per cent could be defined as closet trackers.
The report concluded that “nearly half UK retail funds may have been misleading the public and breaching the FCA’s over-riding principles that firms ‘must conduct their business with integrity, and communicate information in a way that is clear, fair and not misleading’”.
SCM called on the FCA to bring in “US standards of transparency to reform these practices and prevent misrepresentation to investors by significantly improving consumer protection and increasing ethics and fairness within the UK fund management industry”.
