It remains one of the biggest deceptions within the fund management industry - The closet tracker!
The debate over whether you should invest in active funds (those run by a manager) or passive funds (those run by computers that hug an index) rages on. Yet 80-20 Investor subscribers know that I think the argument is pointless. 'Passive champions' point out the low cost of trackers and active management underperformance while active managers shout from the roof tops when they actually do outperform passive investments.
The reason why you shouldn't care is that you should focus on the net performance after charges. Then you can compare apples with apples. That is why all 80-20 Investor published fund performance data is net of charges.
But there is a flaw to the whole debate that no one seems to point out and that is the assumption that once you've made your choice you have to stick with it! The art to successful investing is to regularly review your investments and make necessary changes to boost your returns. So you will end up investing passively when it's working and invest actively when the fund managers are actually making some money.
However, I appreciate that some people will want to employ a buy and hold strategy for at least part of their portfolio. But if you decide to invest in an active fund for the long term then you expect the manager to be doing something other than just tracking an index while charging you through the nose for the privilege. Otherwise you would make more money simply buying an ETF which tracks the same index for a tenth of the cost.
But the problem is that you never know if a fund is a closet tracker until it's too late.
The 20 closet trackers with over £10billion of investors' money
I analysed every unit trust available to UK investors and identified 20 closet trackers. If you have these funds in your buy and hold portfolio then you may want to review their inclusion. It doesn't matter whether the manager is intentionally hugging the index or not. If it looks and feels like a tracker then it is a tracker.
To identify these closet trackers I followed the following steps:
- I identified the benchmark for every fund. Every fund has a published benchmark which their manager measures themselves against.
- I then assessed how each fund performed compared to its index over 5 years. To do this I identified those funds where the movement in the fund's price was almost exclusively down to the movement in the benchmark (using a statistical measure called r-squared).
- I then looked at the tracking error, which is a measure of how closely a fund's movements actually deviate from that of the index throughout the past 5 years.
- I then screened for those funds with ongoing charges (called the OCF) higher than a typical tracker fund
The table below gives a roundup of the 20 closet trackers I identified. In each case they have all unperformed the index they 'track'. Typically the higher their annual charge the more they underperformed. At the foot of this article I have charted one of the funds to demonstrate just how much it tracks its index.
| Fund | Sector | Fund Benchmark | 5 year r-squared | 5 year Tracking error | Fund Size(m) | Annual charge |
| AXA Rosenberg Asia Pacific Ex Japan | Asia Pacific Excluding Japan | MSCI AC Asia Pacific ex Japan | 0.94 | 1.04 | 213.8 | 0.82 |
| F&C Pacific Growth | Asia Pacific Excluding Japan | MSCI AC Asia Pac ex Jap | 0.95 | 0.92 | 52.9 | 1.86 |
| Halifax Far Eastern | Asia Pacific Excluding Japan | MSCI AC Asia Pacific ex Japan | 0.96 | 0.77 | 233.1 | 1.49 |
| PUTM Far East | Asia Pacific Excluding Japan | MSCI AC Asia Pac ex Jap | 0.97 | 0.7 | 50.2 | 1.36 |
| Scottish Widows Pacific Growth | Asia Pacific Excluding Japan | MSCI AC Asia Pacific ex Japan | 0.96 | 0.77 | 130.8 | 1.76 |
| HSBC Chinese Equity | China/Greater China | MSCI China 10/40 Index | 0.93 | 1.4 | 27.1 | 1.89 |
| JPM Multi Manager Growth | Global | FTSE All-Share Equity Investment Instruments Ind.. | 0.8 | 1.19 | 404.3 | 1.43 |
| Newton International Bond | Global Bonds | JP Morgan GBI Unhedged TR | 0.81 | 1.64 | 373.1 | 0.78 |
| Threadneedle Global Bond | Global Bonds | JP Morgan Global GBI | 0.8 | 1.56 | 432.6 | 1.42 |
| Scottish Widows Emerging Markets | Global Emerging Markets | MSCI Emerging Markets | 0.98 | 0.61 | 1353.1 | 1.69 |
| Baillie Gifford Emerging Markets Bond | Global Emerging Markets Bond | JPM GBI EM Global Diversified Composite Index | 0.95 | 1.36 | 877.2 | 0.76 |
| Threadneedle Emerging Market Local | Global Emerging Markets Bond | JPM GBI EM Global Diversified Composite Index | 0.94 | 1.31 | 87 | 1.72 |
| Halifax Japanese | Japan | MSCI Japan | 0.97 | 0.64 | 95.5 | 1.44 |
| Santander Japan Equities | Japan | FTSE World Japan Index | 0.97 | 0.58 | 49.3 | 1.08 |
| Scottish Widows Japan Growth | Japan | MSCI Japan | 0.97 | 0.64 | 207.9 | 1.63 |
| Barclays Sterling Corporate Bond | Sterling Corporate Bond | Markit iBoxx Sterling Non Gilts | 0.97 | 0.33 | 253.7 | 0.92 |
| HSBC Corporate Bond | Sterling Corporate Bond | iBoxx Sterling Corporates Index | 0.98 | 0.42 | 1193.8 | 1.15 |
| Halifax UK Growth | UK All Companies | FTSE All Share | 0.92 | 0.79 | 4863 | 1.37 |
| HSBC Gilt & Fixed Interest | UK Gilts | FTSE GILTS ALL STOCKS | 1 | 0.18 | 53.8 | 0.91 |
| Threadneedle Sterling Bond | UK Gilts | FTSE UK Gilts Government (All) | 0.99 | 0.15 | 289.8 | 1.17 |
So what should you do if you have a closet tracker?
Closet trackers only become an issue if you buy and hold them for the long term because you could make more money buying a cheap ETF or tracker fund that was designed to track the given index in question. It's interesting to see banks and insurers make up a large proportion of the closet tracker list as their business model is built upon profiting from customer inertia (be it savings accounts or funds) and shoehorning them into expensive products. It's another reason why you shouldn't invest through them. So if you have been investing in any of these closet tracker funds for an extended period of time in the belief that the manager is actively managing things then it's time to review your strategy.
Of course when you invest based around momentum there will be times where a certain index (and therefore its closet trackers) will outperform other funds. That's ok because you are not investing in the fund under the belief it is doing anything other than closet tracking. Inevitably its star will wane and you will move out of the fund when you review your portfolio in the future. Every dog has its day, even a closet tracker.
An example of a closet tracker
Click on the image to enlarge it.
