With some passive funds featuring a total expense ratio (TER) of as low as 0.25 per cent, there are many who claim that index-plus "active" funds will soon be a thing of the past.
However, in spite of this, there are a number of funds in the IMA universe, some with more than £1bn assets under management (AUM), that charge fees for an actively managed service yet provide the performance of a tracker fund.
FE analysts define a "closet tracker" fund as one with an Alpha between -3 and 3 per cent over three and five years, a Beta of 0.9 to 1.1 over three and five years, and a tracking error of less than 5 per cent over these time periods.
Tracking error, Alpha and Beta of funds
| Tracking error | Alpha |
Beta |
||||
| Name |
5-yr (%) |
3-yr (%) |
3-yr (%) |
5-yr (%) |
3-yr |
5-yr |
| SWIP - MultiManager UK Equity Growth |
2.13 |
1.57 |
0.09 |
0.13 |
1.01 |
1.03 |
| SWIP - MultiManager UK Equity Focus |
2.5 |
1.51 |
-0.89 |
-0.32 |
1.01 |
1.02 |
| HSBC - UK Growth & Income |
2.52 |
1.73 |
-1.31 |
0.06 |
0.99 |
0.97 |
| Premier - Castlefield UK Equity General |
2.66 |
2.47 |
-1.41 |
-0.62 |
1.03 |
0.99 |
| Halifax - UK Growth |
2.7 |
2.05 |
-1.2 |
0.24 |
1.03 |
1.02 |
| Santander - N&P UK Growth |
3.01 |
2.72 |
-0.13 |
1.38 |
0.98 |
0.96 |
| Legg Mason - UK Equity |
3.41 |
2.79 |
-2.02 |
-0.85 |
1.07 |
0.99 |
Source: FE Analytics
According to FE research, there are seven funds in the IMA UK All Companies and UK Equity Income sectors that fit the bill – three of which are under the management of SWIP.
All seven have fallen short of their FTSE All Share benchmark over three years, and all but one – Santander N&P UK Growth – has underperformed over five years. With a TER of 1.91 per cent, Legg Mason UK Equity is the most expensive of the seven, and it is also the worst performer over five years with losses of 14.48 per cent.
Performance of funds vs index over 5-yrs
Source: FE Analytics
In contrast, the two cheapest funds – Santander N&P UK Growth and HSBC UK Growth & Income – are the best performing over a five-year period.
Inevitably, all of the companies have a large cap focus, with major stakes in the UK’s biggest companies. All seven include Vodafone, GlaxoSmithKline and BP in their top-10 holdings.
The top five holdings of the Santander N&P UK Growth fund, for example – Vodafone, BP, HSBC, GlaxoSmithKline and Shell – are among the seven biggest companies in the UK by market cap.
However, Santander denies that its fund is a closet tracker.
"UK Growth is an actively managed portfolio run with a slight preference towards larger cap stocks," said a spokesperson for the group.
"It is seen as a core portfolio and will naturally have a relatively low tracking error versus more aggressive high Alpha funds but as the performance data shows, this fund is by no means a closet tracker.
However Rob Gleeson, head of research at FE, believes investors would be much better off investing in a low-cost passive fund than these low-Alpha portfolios.
"If a fund has a high correlation to its benchmark, a Beta close to 1, and little to no Alpha then it is unlikely to offer significant benefits over a passive fund and is probably making little attempt to do so," he explained.
"The traditional measure of active management, tracking error, can be misleading; many indices contain far too many stocks for funds to invest in them all."
"Tracking error often represents imperfect replication rather than any significant decisions being made by the fund manager."
"However, regardless of this, a lot of these funds have a tracking error lower than the average passive fund."
Gleeson points to the cautious nature of many fund managers who prefer not to stray too far away from their benchmark.
"Managers have a strong incentive not to stick their heads above the parapet and remain average," he said.
"However, while this cautious approach makes sense for them, it doesn’t make sense for the investor; average performance can be obtained much cheaper through a tracking fund."
"Active funds come with an element of risk – you’re paying for a manager who is willing to take a chance and beat the market, anything less than this is not value for money."
The £3.8bn Halifax UK Growth portfolio is the largest of the seven featured in the study. Launched in 1969, it is one of the oldest and most established funds in the entire IMA unit trust and OEIC universe.
However, with a tracking error of just 2.05 per cent over three years, and an Alpha consistently around the 0 per cent mark, it has failed to justify its 1.51 per cent TER in recent years.
Commenting on the study, SWIP, which manages the portfolio, emphasised that it is an actively managed fund that aims for long-term outperformance.
With regard to SWIP MultiManager UK Equity Growth, the group said: "The five-year performance of the fund, where Russell Investments acts as an investment adviser, is not as strong as we would like."
"However, the three-year performance of the fund reflects a positive trend and in our view represents a compelling risk-adjusted outcome."
According to FE data, SWIP Multimanager UK Equity Growth, which has a TER of 1.82 per cent, has underperformed its FTSE All Share benchmark by around 5 per cent over three years, with slightly more volatility.
Performance of fund vs benchmark over 3-yrs
Source: FE Analytics
Raphael Sobotka, head of multi-manager Europe at HSBC, points to the strong long-term track record of the HSBC UK Growth & Income portfolio.
"Over the long-term, since its launch in August 1998, the fund has outperformed, achieving a return of 80 per cent, against a UK All Companies sector average of 63 per cent and the FTSE All Share’s 69 per cent [to end of April 2012]," he said.
"The portfolio is generally considered to be a lower-risk fund compared with many of its peers but having offered better downside protection in major market corrections."
In 2008, the fund lost 29.2 per cent – 0.73 per cent less than its FTSE All Share benchmark. In 2002 it lost around 6 per cent less than the index.
Sobotka also emphasises that a portion of the portfolio is invested in other funds. Aberforth UK Smaller Companies, for example, sits in HSBC UK Growth & Income’s top-10.
"We select and blend the best-in-class external fund managers who run parts of the fund for us to specific mandates. This is clearly not tracking, it's very much active management and attempting to add value and generate extra risk-adjusted returns," he added.
Mark Elliot, who heads up the Premier Castlefield UK Equity General fund with David Soutar, says the fund is overweight mid caps, and has no exposure to tobacco.
"The vast majority of money in the fund belongs to charities, so we don’t invest in tobacco on ethical grounds," he commented. "The AMC [annual management charge] for charities is 0.6 per cent, which is much cheaper than the retail share class [1.25 per cent]."
Legg Mason declined to comment.