Regardless of where you stand in the active versus passive debate, the “real enemies” of investors are lazy managers who masquerade as being active while giving sub-standard returns, says Premier’s Simon Evan-Cook, who also suggests that UK funds are the worst offenders when it comes to this.
The argument over whether active or passive management leads to the best outcomes for investors has raged for decades and, despite much research attempting to win the debate for either camp, it looks unlikely to end any time soon.
Passive advocates maintain that no active manager can consistently outperform therefore it’s wrong for them to charge expensive fees to do so. Disciples of active management point out passives guarantee underperformance and preach that genuine stars can handsomely reward their investors over the long term.
Simon Evan-Cook, senior investment manager on Premier’s multi-asset fund range, argues that more attention needs to be paid to ‘closet trackers’ - or funds that market themselves, and charge investors, as though they were genuinely active but in reality differ very little from their benchmark.
“While we frequently lock horns with the passive camp, we think the real enemies are closet trackers. This sub-sector of the investment industry masquerades as active management to justify higher fees, but provides a service that is little different (and frequently inferior) to cheaper index trackers,” he said.
“The most obvious problem with closet trackers is that they are poor value for money. Holders of such funds are paying significantly more than holders of the cheapest index trackers, yet they receive worse results (mainly, but not entirely, because of the higher charges they pay).”
FE Trustnet has examined the active versus passive debate on several occasions. For example. at the start of the year FE Research head Rob Gleeson reviewed the academic theories behind the debate while past studies have focused on various metrics investors can use to identify truly active managers.
We’ve also covered when trackers have beaten average funds - such as earlier this year, when seven of the 20 best performing UK All Companies funds of the previous six months were FTSE trackers. And this is a subject we’ll be returning to again over the coming weeks.
Evan-Cook argues that more attention should be paid to a fund’s ‘active share’, which is a measure of how different the portfolio is from its benchmark. An active share of zero means the fund holds exactly the same stocks as the benchmark in exactly the same proportions, while a score of 100 would mean no overlap at all with the benchmark.
His analysis of the UK fund universe breaks down its members into four categories - index trackers, closet index, active and highly active.
This showed that almost 30 per cent of assets - or £58bn - in the IMA's UK equity sectors are held in those falling into Evan-Cook's closet index category, or those with an active share of between 15 and 60.
IMA sectors by active share and assets under management
Source: Premier Asset Management
It makes the UK sectors by far the worst when it comes to closet trackers. In the asset class in second place - global emerging market equities - just 15 per cent is in the passives pretending to be active.
This is also in stark contrast to the Japanese equity sectors, where just 3.2 per cent of assets are held in funds that could be considered closet trackers.
The difference in returns from the different types of fund is significant. Over the past market cycle the average ‘highly active’ UK fund has returned an annualised 7.5 per cent against the FTSE All Share’s 4.8 per cent.
Meanwhile, the average low-cost tracker has managed to slightly outperform the All Share with a 4.9 per cent annualised gain. But those funds classed as closet trackers have returned just 4.6 per cent on an annual basis.
Evan-Cook has thoughts on why the UK’s funds market has more index-tracking ‘active’ funds than its global competitors, centred around home bias and the “cost naivety” of many UK investors.
“We believe it is because of the make-up of products held by less sophisticated fund buyers. Firstly, such buyers have a bias to home-market funds. So when Mr & Mrs Smith walk in to their building society, or speak to their life insurance provider, the path of least resistance is to buy an own-brand UK equity fund, not a Japanese equity fund,” he said.
“These investors are also the most likely buyers of closet trackers: They have no way of knowing whether a fund is genuinely active or not, or even that such a thing matters. They are also less likely to dump a fund unless short-term performance is really bad.”
“As such, providers in this part of the market (and it is a separate market - closet trackers are not marketed to professional fund buyers) make sure this doesn’t happen by hugging the index. This has the unfortunate corollary that performance is never really good either, and is usually worse than the tracker because of the ‘active’ charges.”
So why is this important when it comes to the active/passive debate? Evan-Cook believes lumping these closet trackers in with the genuinely active funds makes active management look worse than it really is.
“Closet trackers unfairly tip the passive-active debate in favour of passive. Despite being neither one nor the other, they are classed as fully active funds in statistical studies. Given they are all-but-a shoo-in to underperform the market by even more than genuine trackers, they inevitably drag the performance of the ‘average’ active fund down," he said.
"It is like trying to calculate the average fuel efficiency of cars in the UK, but including lorries in your study.”
While fans of passive investment point out that it’s incredibly difficult to pick a good active fund at the time the manager’s style is suited to market conditions, Evan-Cook says that being aware of the closet trackers lurking in the industry can help investors to immediately avoid some of the weaker funds.
Over the coming weeks, FE Trustnet will research the funds in some of the most popular IMA sectors to identify those that look like closet trackers - and seek an explanation from the managers behind them.
