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Weekend reading: Time to expose the closet tracker funds

Weekend reading

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

Active investing

Other articles

Product of the week: ThisIsMoney says the new 2.5% three-year fixed rate savings account from Paragon Bank is a best buy. Be aware it isn’t likely to hang around for long.

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

Other stuff worth reading

  • Easy ways to think about hard finance stuff – Housel / Fool US
  • ‘Generation Rent’ is in denial about housing costs – Telegraph
  • The highest paying jobs of 2014 – Guardian
  • The codeword that triggers better customer service – Telegraph
  • There are much better ways to board planes – The Atlantic

Buy of the week: No new investing book this week, but these long nights were made for the telly, anyway. Amazon is offering £10 off the Amazon Fire TV, bringing the price down to just £69. The device is compatible with all the major subscription and streaming services.

Like these links? Subscribe to get them every week!

  1. Reader Ken notes that: “FT articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.” []

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{ 9 comments… add one }
  • 1 Charlie November 29, 2014, 4:42 pm

    Fascinating as ever.

    Again, I value what you all do here very highly and have invested variously on the back of your brilliant expositions.

    Thank you.

  • 2 dearieme November 29, 2014, 5:55 pm

    The Blessed Merryn made that point recently in the FT. She suggested that some active traders can do very well; the ones guaranteed to do poorly are the expensive closet trackers. I’d still like to know how I am to find the good guys – apart from buying Scottish Mortgage and praying a bit.

  • 3 dearieme November 29, 2014, 5:57 pm

    I didn’t know that Americans spell “glamour” like that; but then I haven’t labored to find out.

  • 4 BeatTheSeasons November 29, 2014, 8:14 pm

    I’m not sure just exposing the closet trackers will make much difference – you can invest in a Virgin FTSE tracker where the annual charge is 1% even though it’s quite openly no more than a tracker fund that charges 10 times as much as the others for doing the same thing. Presumably some gullible investors imagine that Richard Branson’s business acumen will somehow rub off on the fund an improve the returns….

  • 5 david November 30, 2014, 2:52 pm

    @BeatTheSeasons – i imagine many people are wary of finance funds because of madoff etc, so a big non-finance brand name like Virgin could be attractive to retail savers who have never gone into the markets before. it’s sad that virgin is taking advantage of people with such a high cost, but if these people would never have gone into the markets otherwise a high-fee tracker is better than nothing i suppose. hilariously, branson denied it was underperforming – billionaires probably don’t worry about their fund costs too much.

  • 6 bob December 1, 2014, 1:36 am

    3 certainties in life: Death, taxes and Dearieme whiterring on about grammar on the Monevator comments section (and UTMT for that matter).

    The forum equivalent of David Mellor in the back of a taxi.

  • 7 The Investor December 1, 2014, 2:19 pm

    @bob — The thing I don’t understand about these grammar nitpicks (there’s another on property article from Friday) is that I would genuinely estimate Monevator to be in the top 0.1% of sites when it comes to vocabulary, punctuation, and grammar. Perhaps the 0.01% if you exclude the mainstream newspapers who still have sub-editors and so forth (we just have me! 🙂 )

    If the cause is so important, fight it where you’ll get more bangs for your buck (sorry, before the complaints I mean “more bangs for your pound sterling — we’re not the US yet you know!” etc etc 😉 ).

  • 8 kean December 1, 2014, 6:56 pm

    Whatever the motivation behind Threadneedle’s desire to compel a new industry standard, if it does take hold then I can only assume that the next stop will be Fund Mgrs’ pay and reward scales (i.e. performance incentives in general whatever form they currently take). This can only be good for the investors at large surely!

    @BeatTheSeasons – if SOME investors don’t take notice then it is their look out. Take horse to the water ….., etc, etc. 😉

    I also think the industry should push the Passives/ETFs to make their tracking error/difference more readily accessible and easily digestible. I personally get quite irritated that I have to go hunting (normally by using other 3rd party’s resources) and deduce these performance indicators every time I need to make a decision.

  • 9 dearieme December 1, 2014, 10:44 pm

    It’s “wittering”, Bob. If I were David Mellor, surely I’d call you an ignorant prick? And I haven’t.

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