Many active funds accused of ripping off investors
Investors being conned by active funds that are "expensive clones" of the stock market.
Pay for an actively managed fund and it is only fair to assume that means someone is actively managing the fund. Unfortunately, that is often not the case.
More than a third of funds marketed as actively managed are just “expensive clones of the stock market” according to research by wealth management company SCM Direct. They class a clone as a fund that has less than 60% of its holdings differing from the index it is benchmarking.
“The UK industry is more than 10 years behind the US in giving consumers transparency of holdings, in full, via the internet,” says Gina Miller, founder of SCM Direct. “Similar transparency in the UK would quickly reveal the 36% of UK funds potentially defrauding the public by pretending to be truly active and offering something different to cheaper index products.”
There is a lot of money at stake here. In total SCM Direct say the funds that take extra fees for active management, but in fact clone indices took £800 million deceptively from investors in 2014 alone. The firm is now calling for a full investigation into the practice.
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Paying for 'expertise'
The news has reignited the old argument about whether you should ever pay for actively managed funds or just opt for a low-cost portfolio of tracker funds.
If you opt for an actively managed fund you’ll pay extra for the expertise of the fund manager. Typically these fees range from 0.85% to 1%. In contrast, if you opt for a passive fund that simply tracks an index you could pay as little as 0.1% in fees.
That may not sound like much but it can make a big difference to your returns. An investment of £10,000 would lose more than £1,600 over 10 years in fees with an active manager charging 1% compared to a tracker fund charging 0.1%, assuming they both manage annual growth of 7%.
“With a growing focus on investment charges, active funds need to demonstrate that they can add real value otherwise they will find investors, quite rightly, heading to the exit door, says Patrick Connolly, a certified financial planner for Chase de Vere.
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Does this really make them a 'closet tracker'?
According to SCM and others within the investment industry, having less than 60% of a fund actively invested makes the fund a closet tracker. But why 60%? And is that even true?
Investment company Hargreaves Lansdown argues that this definition doesn't make much sense, pointing out that a fund which had 50% invested in the FTSE100 and 50% invested in cash would be classed as a closet tracker. However it would likely perform significantly differently to the index - if the FTSE100 dropped 30%, the fund would only drop 15%, meaning it would actually outperform the index.
It also picked out the Majedie UK Equity fund, which has had an active share below 60% for most of the last five years, yet has beaten its benchmark by 19% over that period.
Are fund managers worth the fees?
You should only invest in an active fund if “you have a reasonable expectation that the active manager you are investing with has a good chance of delivering outperformance” says Laith Khalaf, senior analyst at Hargreaves Lansdown. “Out of the several thousand funds out there, there are probably around 100 proven fund managers who fit into this category.”
These managers are worth seeking out though as they have the potential to generate considerable additional wealth, says Khalaf.
One way to tackle the decision between active and passive funds is by looking at what kind of stocks you want to invest in. There are some areas which are more suited to active managers than others.
“It can be most difficult for active managers to out-perform in more efficient markets such as large cap UK and US equities,” says Patrick Connolly. “Here information about individual companies is widely known by the market so managers will struggle to find opportunities their rivals have missed.”
If you are want to invest in large cap US or UK equities there are some good, low-cost passive funds that can do the job.
The cheapest FTSE 100 tracker is the Legal & General UK 100 Index. It has an ongoing charge of just 0.1%. For exposure to US large caps then the Fidelity Index US had an ongoing charge of just 0.1%.
However, if you want to include small caps or emerging markets within your investment portfolio then active managers can be worth their fees.
“The UK Smaller Companies sector is a fertile hunting ground for active managers and funds like Marlborough UK Micro-Cap Growth and Standard Life UK Smaller Companies have taken full advantage of this fact on behalf of their investors,” says Khalaf.
The Marlborough UK Micro-Cap Growth fund is managed by Giles Hargreave and has a 1.5% annual management charge. Over the past five years it has delivered growth of 143.7%. In contrast the UK smaller companies index has returned 99.2%.
The Standard Life UK Smaller Companies fund is run by Harry Nimmo, charges 1.6% per year and has returned 113.4% over the past five years.
“For many investors the best approach could be to hold a combination of active and passive investment funds,” says Connolly. “Active funds should be held in sectors where the fund manager has a better opportunity to out-perform but passive funds should be considered where out-performance is less likely.”
If you do hold active managed funds, make sure you keep an eye on them. If they aren’t delivering returns that warrant the higher fees move your money.
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