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Tracking error hits passives

A Financial Express study highlights major discrepancies between the performance of UK indices and funds that are supposed to be following them.

By Lora Coventry, Senior Reporter, Financial Express
Tuesday April 05, 2011

Investors are missing out on up to 5 per cent a year on returns from passive funds, as tracking error hits earnings.

A study from Financial Express shows investors who put cash into a FTSE 100 tracker a year ago could have realised returns of anywhere between 5.82 per cent and 11.52 per cent, depending on the vehicle they had chosen. Those returns factor in charges.

FTSE 100 tracker funds over 1-yr

Fund 1-yr returns (%)
Elite - Henderson Rowe Dogs FTSE 100 11.52 1.9
HSBC - FTSE 100 Index
7.2 0.27
Cler Med - FTSE 100 Tracker
6.58 1
Royal Bank of Scot - FTSE 100 Tracker
6.28 1
Halifax - UK FTSE 100 Index Tracking
5.82 1.52

Source: Financial Express Analytics

Phil Reid, HSBC’s head of UK external distribution, said: "Tracking error is a key indicator of how well a manager is doing his job. Performance also depends on issues such as how closely the fund is tracking its index; physical replication will mean a tighter tracking, for example."

The data also shows large differences between those funds’ charges; Halifax’s UK FTSE 100 Index Tracking fund, the worst-performing FTSE 100 tracker, has a total expense ratio (TER) of 1.52 per cent, while the second-best performer, HSBC FTSE 100 Index, charges 0.27 per cent TER.

The FTSE 100 index returned 9.07 per cent in the year.

The same pattern is true of funds tracking the FTSE All Share – although the values are less extreme. The Vanguard FTSE UK Equity Index gave the highest returns, with 9.12 per cent over a year, while the Halifax FTSE All Share Index tracker returned the least, with 7.39 per cent.

Vanguard has the lowest TER of the All Share trackers with 0.15 per cent, while Halifax was the most expensive, charging 1.5 per cent.

The FTSE All Share returned 9.2 per cent over the past 12 months.

The Halifax FTSE 100 Tracker and the Halifax FTSE All Share Tracker were part of a fund transition from Insight to SWIP that took place last year. Halifax was not available for comment.

HSBC’s FTSE All Share Index Tracker and F&C’s vehicle that follows the same index both returned just over 8 per cent in the period, charging 0.27 per cent and 0.44 per cent respectively.

AWD Chase de Vere’s Patrick Connolly says outperformance within a tracker fund can also be cause for concern.

"The performance of all investment funds is important. However, if you have selected a passive investment then the key is how accurately it tracks the relevant index that it is supposed to be following."

"If a fund significantly outperforms the index, this suggests that its tracking techniques may not be very accurate and so there is a possibility that it could significantly underperform at some point in the future."

"It is important to understand that one tracker fund is not necessarily like another and they may charge different amounts and try to achieve their goals in different ways."

"We prefer to use experienced passive managers such as Legal & General who typically use full replication of the index and so reduce the risk of divergence away from their benchmark significantly."

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megastream Apr 08th, 2011 at 10:57 PM

Yes - extremely sloppy journalism. The article states "A study from Financial Express shows investors who put cash into a FTSE 100 tracker a year ago could have realised returns of anywhere between 5.82 per cent and 11.52 per cent, depending on the vehicle they had chosen." I repeat - the Elite Henderson Fund (the 11.52 % gain)is NOT, REPEAT NOT a FTSE 100 tracker.
Yet the article includes it as a FTSE 100 tracker.

Pascal Dowling Apr 07th, 2011 at 12:23 PM

Take a look at the detailed brochure that comes attached to this fund. You will see that this identifies it as a passive fund. It is referred to as a 'mechanical portfolio', selecting 15 stocks using a quant screen [i.e. a computer] that identifies those with the highest yield.
There is a minimal active overlay; basically the manager checks to make sure the computer hasn't picked a complete basket case - which may explain why it has such a high TER - but manual stock selection doesn't come into it and this article is correct to include it among the passive funds it refers to. Slopppy journalism indeed.

Theo Apr 08th, 2011 at 01:24 PM

Mr Dowling, I think you are right, but it is all about semantics. The dogs fund is passively managed in the sense that the manager is only minimally involved, but it is not an index tracker and most people assume the two terms are synonymous. However, its investment remit is entirely different from that of all the other funds in the table and has no place in it. It is obvious it was included to advertise it. A very minor, obscure,fund with abysmal 5yr performance and frightening TER, which this year had a flash in the pan.

megastream Apr 05th, 2011 at 04:29 PM

You said "and so I disagree that your suggestion that it makes the whole piece inaccurate and misleading. I fail to see how this is the case, but then I do have a vested interest as I am editorial director at Trustnet, and I'd be happy to hear your view explained in more detail" OK - your comment was made to another responder, but it could have been me - his response was displayed just as I was preparing an almost identical response.
If you want to display an article on FTSE 100 trackers, and tracking error, then I have no idea why you think it appropriate to include an obscure fund that selects 15 Dogs from the FTSE 100. If you wanted to use as a comparison some non-index tracking fund, then there are many well known, and much used funds which you could have selected. No - your article looks like sloppy journalism - you saw the word FTSE 100 and included it in a list of FTSE 100 trackers.

Theo Apr 05th, 2011 at 05:31 PM

Mr Megastream, I agree entirely with you on the illogical inclusion of the Elite-Henderson fund. Actually I thought it was an index trackin fund until I saw the correspondence on it.

I now think it was included because the article was really a concealed advertisement for that fund. It beat the index and therefore justified its exorbitant charges. Never mind its terrible 5-yr performance.

Theo Apr 05th, 2011 at 04:26 PM

I have just discovered that the Henderson dog FTSE fund retail has a TER of 2.4%. The figure of 1,9% given in the table above, is for the A shares, presumably institutional. So the article is indeed misleading, as a previous reader has observed. Also their 5-year performance seems to me to be the worst I ever had the misfortune to see. The name Elite makes it a joke

Theo Apr 05th, 2011 at 02:07 PM

If this article is from a substantial study by Trustnet, why are we not shown more data? Where can we read the whole report? Trucking accuracy is not a matter of great concern to those who stay invested for a few years since it is a random variable and what you lose in one year you will tend to gain next year.

Of far greater concern to the writer should have been the greed shown by some companies charging 1.9% for an index tracker, and 13 times more than other companies. They are behaving worse than second hand car dealers under a road bridge and are the reason why people now hold the whole finance industry in such contempt No wonder Halifax were too embarrassed to comment.

They are probably smirking behind their hands thinking they are getting away with it, but people will remember them when it comes to all their other dealings. I would not touch them with a barge pole for anything from now on.

But please tell Vanguard to advertise themselves a little more, we hardly know any thing about how they operate and how to buy their funds.

Pascal Dowling Apr 05th, 2011 at 12:31 PM

The Henderson Dogs funds, as you correctly point out, doesn’t track the performance of the FTSE 100, but neither does the author refer to it as anything except as a reference point – the best performing tracker – against which to contrast performance of the other trackers mentioned in the article. The Dogs fund isn’t actually mentioned in the article text, which focuses on the difference in performance, tracking error and TER among the full FTSE100 trackers, and so I disagree that your suggestion that it makes the whole piece inaccurate and misleading. I fail to see how this is the case, but then I do have a vested interest as I am editorial director at Trustnet, and I'd be happy to hear your view explained in more detail.

Warren Peace Apr 05th, 2011 at 11:57 AM

As its name suggests, the Henderson fund does not fully track the FTSE100, just the "worst" 15. This article is misleading and inaccurate.


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