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One-fifth of UK tracker investors paying 1% for sub-par performance

31 October 2014

Passives are never meant to outperform but 20 per cent of assets in UK All Companies trackers are seeing their returns eroded by fees of more than 1 per cent.

By Gary Jackson,

News Editor, FE Trustnet

Despite moves by leading indexed fund providers to bring down the charges of these low-cost products, more than one-fifth of investors tracking UK equities are paying over 1 per cent for their passives - causing significant dents in their returns.

Yesterday, moves by Legal & General Investment Management to reduce the ongoing charges figure (OCF) on 13 products in its retail index fund range prompted new headlines of a ‘price war’ in the tracking space.

The firm brought down charges by up to 55 per cent in some funds, following price cuts by the likes of Fidelity Worldwide Investment and Vanguard Asset Management, which both took the price of investing in their passives to new lows earlier in the year.

However, our data shows that a significant chunk of index-tracking assets in the IMA UK All Companies sector are held in funds that have OCFs of 1 per cent or more. This compares with an OCF of just 0.08 for the sector’s cheapest offering.

The latest figures from the Investment Management Association show that 10.8 per cent of assets under management in the UK are held in trackers, up from 9.6 per cent one year ago.

In the IMA UK All Companies sector the share in passives is significantly higher at just shy of 30 per cent. The largest tracker in the sector is the Scottish Widows UK All Share Tracker, which has assets of £8.7bn.

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Source: FE Analytics

Despite lower costs being one of the main attractions of index-tracking products, FE Trustnet’s research found that funds totalling £9.3bn - 20.2 per cent of the assets held in the sector’s trackers - charge their investors 1 per cent or more.

The most expensive indexed product we found in the sector is the £103.8m CIS UK FTSE4Good Tracker, which has an OCF of 1.5 per cent.

As a point of comparison, some highly rated active managers are much cheaper: Mark Barnett’s Invesco Perpetual UK Strategic Income fund has clean charges of 0.92 per cent while Nick Train’s CF Lindsell Train UK Equity fund charges 0.77 per cent.

CIS UK FTSE4Good Tracker aims to achieve “above-average capital growth” over the medium to long term by tracking the FTSE4Good UK Index, which covers companies demonstrating strong environmental, social and governance practices.

According to FE Analytics, the fund has underperformed its benchmark over all time frames, as would be expected. The fact that trackers charge fees at all means they are guaranteed to underperform the underlying index - but the higher fees here mean that underperformance has been significant.

Performance of fund vs index and sector over 7yrs

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Source: FE Analytics

Over the past year, the FTSE4Good UK Index has outperformed the average IMA UK All Companies fund, falling by 0.39 per cent against the peer group’s 0.99 per cent decline. However, the CIS UK FTSE4Good Tracker is down 1.77 per cent.

The picture is gets worse over longer timeframes. Over the seven years of the last market cycle, the index has performed roughly in line with the sector with a 30.40 per cent; the tracker has returned less than half of this, growing just 14.67 per cent.

To highlight the eroding effect of high charges on trackers, we built two portfolios - one containing the five most expensive FTSE All Share trackers and one holding the five cheapest - then compared their performance with the index.

The time frame is constrained by the launch of the youngest tracker in the portfolios, which was in March 2010. Since then the FTSE All Share has made 38.32 per cent; the average cheap tracker is close behind with a 36.99 per cent gain but the typical expensive passive rose just 30.61 per cent.

Over three years, the expensive funds are also more than 4 percentage points off the benchmark while the cheapest trackers were just 0.30 basis points behind it.

Performance of portfolios vs index and sector over 3yrs

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Source: FE Analytics

Looking over the past year, when markets became more testing, the FTSE All Share has fallen 1.03 per cent. The cheapest trackers have kept close to this with a loss of 1.06 per cent but the expensive portfolio has lost more than double this with a 2.08 per cent decline.

Honor Solomon, head of retail distribution EMEA at Legal & General Investment Management, says investors need to be aware that not all passives are created equal and a number of factors can influence how effective they are in tracking the underlying index.

“What constitutes the best fit for an investor also includes factors like the size of the fund and its liquidity, the trading strategies used and counterparty risks, as well as how skilled the manager is overall in maximising returns through implementing index changes, corporate actions and dividend enhancement,” she said.

“Index funds are not all the same.”

Next week, FE Trustnet will examine index-tracking funds to see which are the best at replicating the performance of their underlying indices.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.