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Half of UK active funds are 'closet trackers'
24 September 2013
Undisclosed index tracking adds costs and impacts performance, finds SCM Private
Around half of active UK equity funds have a significant allocation that is a direct copy of the broad market, research by SCM Private has found.
The asset manager found that 46% of UK equities funds have an allocation of around 40% that directly copies the composition of the market, meaning investors are paying active fees for often beta-type performance. SCM Private found only around 10% of US equity funds had similar allocations.
Gina Miller, founder of SCM Private stated: “Our analysis shows that nearly half of UK retail funds may have been misleading the public. Because UK funds only have to report what they own once a year, most investors will be unaware that in many cases they are often misled into buying something which turns out to be just an illusion.”
The report, Closet Indexation - A UK Epidemic, found only a quarter (24%) of UK equity funds are “radically different” to the broad market index, compared to two-thirds (65%) in US.
SCM Private said this meant many investors were being charged up to three times as much as a comparable index fund for similar performance, leading to what it said was an overcharging of around £3bn in fees in the past five years.
Miller said more stringent transparency laws in the US meant funds were forced to disclose holdings every three months, rather than annually as is required of UK funds, “making closet indexation much harder in the US to get away with”.
SCM Private also found that 88% of the funds where the fund largely replicated the index underperformed, due to high charges.
It noted that if investors paid a 'typical' active retail fee of an Annual Management Charge (AMC) of 1.5% only on the proportion of the fund that differed from the index, then many investors were effectively paying an AMC of closer to 4%.
Miller added: “Investors are led to believe these copycat funds can beat the market when their inherent construction and high fees make this dream virtually impossible.
There is nothing fundamentally wrong with the construction of these funds but investors need to be fully aware of what they are buying and pay a fair price for it.”
Miller called on the UK regulator, the Financial Conduct Authority, to review SCM's findings and bring in transparency requirements closer to the US model.
“Action is needed to demonstrate that consumer protection is firmly back at the heart of the UK fund management industry. This will never happen whilst the industry trade body, the Investment Management Association, is allowed to set many of its own rules. This is the equivalent of putting Dracula in charge of a blood bank,” Miller added.
Simon Wong of the London School of Economics recently told Global Investor/ISF that conflicts of interest in the asset management industry is a serious problem.