Funds that hide in tracker closet

By DAILY MAIL REPORTER
Updated:

 

Nearly half of all actively managed UK funds are 'closet index tracking' - and short-changing those investors who are paying steep fees for active management. A study by independent consultant WM Company compares the returns on a month-by-month basis from UK growth funds with those from the FTSE All Share index, which many of these funds use as a benchmark.

The study, commissioned by Virgin, found that 42% of the funds were producing gains (or losses) within a 3% margin around the gains from the index. Because the returns are so similar, it suggests the funds must be closely tracking the index. Yet they are charging initial fees of up to 6% and annual fees of up to 1.5%, while tracker funds in general charge no initial fee and 1% or less a year.

Only a third of the funds are producing returns that differ from the index by between 3% and 6%, the study says. This suggests seven out of ten funds in the sector are not fully actively managed.

So while tracker fund investors could pay 0.5% a year to get the same gains as the index, the active fund investor could pay up to 7.5% in the first year to get just 3% at most in excess of the index return - and that's if the active fund manager picks the right shares.

An example of these sorts of funds is Société Generale UK Growth, which aims to reproduce the growth on the FTSE All Share plus 2% a year, providing a steady return with not too much risk. It does this by investing broadly in line with the index, meaning that at least a certain percentage of the fund is invested in the very largest shares such as Vodafone and BP, even if the share is doing badly or has the potential to do so.

By ignoring the shares completely, the fund would get so out of step with the index that it would show big swings in returns (losses and gains) compared with the index. This is bad for fund managers, who define risk as doing worse than their benchmark index. Most private investors, however, would consider that if the share was likely to lose money, they should not be in it at all.

At Merrill Lynch, the UK Dynamic fund doesn't look so feisty when more than a fifth is invested in the four biggest UK stocks - BP, Vodafone, Glaxo and HSBC - although it does not hold as much as a tracker fund would.

Both companies say such measures are necessary for controlling risk and deny that the funds are closet track-ers, because they hold only around 50 stocks whereas there are 800 in the All Share index. This way of managing money is not confined to Merrill and SocGen. Many funds which aim to be 'lower risk', including those from High Street banks and building societies, are run even closer to the index while charging for active management.

In contrast, at Jupiter the fund managers can invest where they like, although they must abide by the law which says funds cannot have more than a tenth of their money invested in just one share. There is also a strict monitoring process which brings the fund managers into line if their portfolios look unbalanced or very high-risk.

So what action should investors take? James Dalby at independent financial adviser (IFA) Bates Investment Services says: 'Investors are better off in a tracker than a dog fund, but if they are prepared to take on more risk, they should go for a fully active fund.'

If investors can pick the right active fund they will be better off, according to Darius McDermott at IFA Chelsea Financial Services.

But he warns: 'There should be a core holding in a portfolio. If you have a large investment, I would say it is worth balancing tracker funds and active funds.'

Maths student Lawrence Turner, 20, from Leeds, started a regular savings plan last October into a tracker fund, Gartmore UK Index, which follows the FTSE All Share. There are no initial charges and there is currently a 0.5% annual charge. He is investing holiday job money and other savings into the fund every month through an Individual Savings Account (Isa), which means all gains are tax-free.

Lawrence, pictured left, who hopes to become an investment banker after graduating from university, became interested in the stock market after a friend loaned him a beginners' guidebook.

He says: 'I don't have enough money to buy individual shares - it's not worth the dealing charges. 'This fund is very straightforward and cheap - it just invests in all the shares in the market.'

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