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Emma Simon: End the scandal of active fees for closet trackers

Fund managers need to come clean and end the ongoing scandal of charging active fees for closet trackers.


You call it a closet tracker, I call it a flexible risk-reduced investment strategy with the potential to deliver alpha returns, net of fees, on a marginal proportion of the client’s fund.

At least I think that was the defence put up by the fund management industry, after new research claimed almost half of all popular equity funds are essentially trackers with super-sized fees.

The research, published by SCM Private, said investors had wasted £3bn over the last five years by paying active management fees on these funds.

Not surprisingly their findings were challenged by the Investment Management Association, which questioned the methodology of this research.

The IMA said SCM had excluded funds of less than £100m, potentially skewing results. In addition it said the “active share” measure (which records the percentage of the fund replicating an index) does not tell the whole story: you need to look at how the rest of the fund is invested.

I am not sure I fully agree with either point. This research many not reflect the whole market, as smaller funds, covering specialist niche areas are likely to have a more active remit. But the fact that almost half of our biggest funds, holding billions in retirement savings, are closet trackers is still pretty shocking.

As to the second point, I think that if 50 per cent of investors’ money  – or more – is just mirroring the benchmark then managers should not be taking the full active fee, even if they are taking significant bets with the rest of the fund.

Surely there should be some kind of blended fee, reflecting the fact that half the work is done by a machine, rather than a highly-paid bonus-pocketing individual?

This becomes even more critical when the fund managers are only taking very small positions against the index with the rest of the fund. These “enhanced trackers” can only ever deliver marginal returns over and above an index fund. And given the track record of many stock pickers their input is as likely to dent, as enhance returns, even before the fee is taken into account.

The IMA says only a fraction of funds fall into this group, but more work needs to be done to identify such funds.

By definition their performance will be pretty pedestrian, but this will also be true of many funds that take a more active approach with your money but have simply backed the wrong stocks.

Currently, investment funds only have to publish a full list of holdings twice a year. In the US it is every quarter. Interestingly using the same SCM analysis just 10 per cent of US funds are deemed ‘closet trackers’.

It would be good to see agencies like Morningstar publish data on the ‘active share measure’ of leading funds. This could enable advisers and more sophisticated investors to identify those funds that have a large and fixed proportion of money slavishly following the index, month after month. Pressure could then be brought to bear on managers to reduce fees, while investors are encouraged to move their money elsewhere.

It would also be good to see the FCA investigate this further. This is not a new problem and should not be ignored any longer.

I recently uncovered an article I wrote in 2002 when it was L&G, rather than SCM (both of whom sell index funds) warning of the danger of closet trackers.

The only difference was that while active managers charged 1.5 per cent, tracker funds were 1 per cent. I have not seen any significant drop in active fees – despite the RDR – but you can now get index funds for just 0.3 per cent. It is time for fund managers to finally come out of the closet and reduce these rip-off fees.

Emma Simon is a freelance journalist


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  1. Oh the old ‘active’ vs ‘passive’ debate again. It always amazes me when it is suggested that whilst passives are available for around 0.3%, you still have to pay 1.5% for an active fund – even post RDR.

    The majority of actives now have AMCs of around 0.75% and OFCs of less than 1%, bringing the comparison much closer.

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