Weekend reading: Time to expose the closet tracker funds

by The Investor on November 29, 2014

Good reads from around the Web.

Moves are afoot to compel active und managers to reveal their ‘active share’ – an indication of the degree to which their portfolios differ from the market.

The greatest benefit would be to highlight closet tracker funds. These are active funds that charge high fees but can only ever deliver less than average returns because they essentially track the market.

Getting market returns while paying high costs is a guaranteed bad deal. A big benefit of market-tracking passive investing is that low charges leave you with more of your own money to compound over time.

The FT says [search result] that some fund managers are already planning to highlight their active share to investors:

Threadneedle Investments, which manages £92bn of assets, said it plans to begin disclosing the “active share” percentage on its fund factsheets and believes others should do the same.

“It’s something would have real merit and we would support seeing developed into an industry standard and normal market practice,” said Iain Richards, Threadneedle’s head of corporate governance and responsible investment.

“There is a valid concern about closet index tracking funds that charge active fees. It’s clear investors need better transparency around this and more consistent disclosure of a fund’s active share measure is one part of the solutions.”

Obviously this could be pressed into service as a marketing ploy for funds that are going through a good spell as much as any noble act of transparency. But it’s still a development I’d welcome.

Some people like to invest in active funds. They need to better understand what they’re buying.

More active might mean better returns…

For one thing, research suggests – at least to some onlookers – that high active share may be a signal that a fund manager has genuine market-beating potential.

I’ve not been convinced by what I’ve read, although I’d stress I’ve not rigorously investigated it all. I’ve simply come across various summaries over the years.

One big hesitancy I’ve had is that it seems obvious that a set of market-beating active funds is going to comprise of mainly funds that don’t look like the index.

If they held the same shares as the index, then by definition they wouldn’t have beaten it!

Yet presumably many of the funds that lose the most also look very different from the index, for exactly the same reason. (This is what gave rise to the practice of closet index tracking in the first place – better for a highly paid fund manager to be safe than sorry).

Perhaps this has all been taken into account in the research into active share. I need to set aside a Sunday to find out.

…but what do you care?

People tend to find what they’re looking for in this sort of thing.

For instance, I like and often link to the writings of the value investing team at Schroders, which has a blog called The Value Perspective.

This week one of their number found comfort in academic research that suggested that as well as a high active share, the best performing fund managers rarely trade:

The great majority of the outperformance of the universe of funds considered by Cremers and Pareek comes from the ‘high active share/long holding period’ group.

In other words, while not specifically on the subject of value, their paper appears to show that being prepared to be contrarian and patient – as value investors often are – plays a big part in achieving strong investment performance.

I sent a link to the article to occasional Monevator contributor The Analyst, as I know he likes to buy and hold for the very long-term.

Yet barely an hour later, I came across other research saying that actually, very high turnover active funds do better.

So I sent him that along as well.

With a shrug.

And that’s another reason to go passive – opting out of all this debate with a smile of ‘who cares’!

Because unless your job is picking shares, there’s no need for ‘beating the market’ to be part of your financial plan anyway.

Note: Thanks to everyone who rallied to the call to Like our Facebook page last week. We’re now well above the 1,000 mark, which hopefully means we’ll reach more people via the all-seeing social network than we did before!

From the blogs

Making good use of the things that we find…

Passive investing

Asset classes versus investment strategy – Rick Ferri
Simple things most investors don’t do – Wealth of Common Sense
Indexing and emerging markets: Myth busted – Vanguard
Explaining ETF premiums and discounts – Vanguard

Active investing

Value and glamour investing: Re-envisioned – Millennial Invest
A dozen business and investing lessons from Bill Murray – 25iq
Seven quotes from Warren Buffett — SeeItMarket
The brutal monotony of all-time highs – Reformed Broker
Catalysts and the paradox of managing money – Oddball Stocks
Be wary of US high-dividend yield stocks – Value Perspective

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1

Passive investing

The cheapest and the most expensive tracker funds – ThisIsMoney
Gatekeepers digging deeper into smart beta [Search result] – FT
Invest internationally and rebalance [US focus, but relevant] – WSJ
Your brain can’t handle the stock market – Bloomberg View
Is there a systemic risk of ETF illiquidity? – CityWire

Active investing

Hedge funds no longer just for rich losers – Bloomberg View
Mohnish Pabrai’s advice to a 12-year old – Forbes
The smart way to think about stock valuations – Housel / Fool US
Is it too late to bet on India? – ThisIsMoney
Red flags to look out for when stock picking – ThisIsMoney