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Does Sarasin move signal new wave of ‘active lite’ trackers?

Following Sarasin & Partners move to produce a bespoke index with Indexx Markets, is this the first move towards firms producing tracker versions of funds?

Following Sarasin & Partners move to produce a bespoke index with Indexx Markets, is the investment world about to be hit by a wave of new ‘active lite’ tracker products?

Last week, Sarasin announced the build of a tailor-made index aimed at outperforming the US equity market in response to rising regulatory costs and the increasing pricing pressure on fund groups.

Consultant firm gbi2 says this is something which could become increasingly prevalent in the future.

Managing director Graham Bentley says such a proposition would be attractive as the next step along from “smart beta”.

“You could have a firm such as MSCI build you an index which is essentially tracking the stocks that an individual fund manager would have selected,” he says.

“This would mean there is a reduction in the usual costs associated with active fund management and you would be getting active management performance and service but with the cost lower at almost passive level.”

Indexx Markets co-founder James d’Ath says that although illiquid assets, including private equity and property, cannot be built into an index, all other well-defined processes can.

“It’s like creating a suit in some ways,” he says. “You’ll have one customer who knows exactly what he wants, from his lapels to his buttons. Whereas this guy knows he wants a suit, but apart from a bit of cloth round his shoulders, he’s not too sure.”

Sarasin hopes to launch a fund following the unveiling of the Sarasin US Systematic Efficient Strategy Indexx in the next few months, subject to demand.

However, Bestinvest managing director Jason Hollands says the move could present some problems.

He says some fund managers may be reluctant to publish full portfolio details of their own funds through fear of being mimicked by a passive version.

“Woodford Investment Management wanted to set new standards of transparency by openly disclosing their entire portfolio on their website, a commendable move in many ways,” he says. “But if the outcome ends up being that other firms seek to take that intellectual property and replicate it at lower costs, then it would be entirely the right move to roll-back such disclosure.”

He adds that the timing of any transactions would also be one step behind any particular fund manager and could also open up legal issues if they claimed to replicate a specific fund group’s product.

He says: “I think there would be a number of issues for any firm trying to provider cheaper, generic copies of actively managed products. Firstly, getting access to the full portfolios, since most funds only disclose their top 10 positions for this very reason with the full portfolio only provided to clients under non-disclosure agreements. Secondly, they would not be able to replicate the time of trades in the portfolios, at best only learning of major moves where stock exchange disclosures are required or from monthly fact sheets. Therefore their timing would lag.

“Thirdly, it is inconceivable they could market these stating the name of the brand they are seeking to ape without facing potential litigation for brand encroachment. Try launching a fizzy drink called Copy of Coca Cola and see how long it takes to get slapped with a writ.”

Charles Stanley Direct head of investment research Ben Yearsley says the fact that a tracker would be unable to hold unquoted stocks could also present a problem to the model.

“It would be difficult because the tracker provider would not know when the said fund manager had sold a particular stock unless the fund manager agrees to the passive being set up in the first place, which is unlikely.

“In addition, the passive would not be able to track any of the unquoted holdings the fund manager has.”

Thomas and Thomas Financial Services managing director Darren Lloyd Thomas says hybrid products are a symptom of the industry’s obsession with cost and that active management will always come at a price.

He says: “I think these kind of products would essentially be closet trackers and you would end up with a poor relative of a good fund. People are becoming too focused on cost and that is not good, if you actually want a manager who is going to deliver value then you do have to pay the costs associated with that.”

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  1. I think there’s a misunderstanding here. This isn’t about replicating someone else’s portfolio, Jason. It’s about replicating one’s own stock selection process. You build an index that mirrors the stocks your selection process identifies; all indices merely reflect the price movements of their constituents – they don’t hold the constituents themselves. A fund that tracks that index, however, would normally have to hold the constituents and that might involve issues such as those expressed by Ben. However, the advantage I see is that the fund mirroring the “active index” wouldn’t buy the stock – it would hold a total return swap (in exchange for a premium) created by a third party, eg investment bank. The swap would reflect the price of the index (itself an aggregation of underlying constituents’ prices). Your liquidity risk is confined to the counterparty to the swap (since you don’t hold the stocks themselves). Fund managers are already using futures contracts as a cheaper way of exposing themselves to securities.

    I see “virtual stock selection”, ie customised indices built to reflect a manager’s process, as an entirely legitimate route to cheaper (and hence better performing) active management.

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