Is Your Active Fund Hiding In The Closet?

Is Your Active Fund Hiding In The Closet?
Underwater by Julian Cohen. Why?

Are you one of the investors who are set to pocket a share of the £34 million in compensation from asset managers whose active funds have been assessed by the regulator as closet trackers?

The Financial Watchdog Takes Action On Closet Trackers Following Its Review Of The Asset Management Industry

The Widespread Issue Of Closet Trackers

The Financial Conduct Authority’s mission to ensure value-for-money for investors, set out in its Asset Management Market Study Report, has concluded that closet trackers are passive, but look and charge like they are active.

As a result, investors in closet trackers are paying much higher fees than they need, resulting in lower net returns as a consequence.

What Is A ‘Closet Tracker’ Fund?

A closet tracker has two features:

It delivers a return that’s remarkably similar to the underlying market in which it invests, by limiting the risk it takes (the ‘tracker’ feature).

It doesn’t adequately disclose the tracker behaviour (the ‘closet’ feature), which allows the fund to charge an higher active fee.

The State Of The Closet Tracker Market

The Financial Conduct Authority Market Study identified more than £100 billion tied up in funds that hugged their index or benchmark.

Closet trackers aren’t just found in the UK.  Previous research by the European Securities and Markets Authority found between 5 per cent and 15 per cent of the funds it examined are closet trackers.

The high price of stockmarkets have made it particularly tricky to spot closet trackers.  Their fund performance has been boosted in current market conditions, where previously they had lagged behind the market.

A number of asset managers whose funds charge investors higher management fees, but deliver fund performance that simply tracks a benchmark or index, will compensate investors to the tune of £34 million.

Strangely, it’s not an official compensation scheme. 

All that’s required is that those managers who’ve been promoting closet trackers will be required to change their marketing material. 

Only in more serious cases of misleading investors will the managers be required to notify existing investors.

In its initial recommendations to asset managers, the regulator wants to see included clearer figures on what investment funds will cost.  It’ll also expect the managers to pass on more cost efficiencies as funds grow in size, as well as making it easier for investors to switch between funds.

The Financial Conduct Authority’s Findings

Here’s the watchdog’s conclusion after reviewing 84 funds:

In summary, 20 of these funds were adequately describing how investors’ money was being managed.  Of the remaining 64 funds, we are working together with firms on 42 of them.  22 funds have already made improvements.  Often, these fund disclosure changes were not material and only required clarification.  Overall, £34m in compensation has been paid to funds and investors.  Separately an enforcement investigation is on-going against a firm.

It’s pretty shocking to read that exactly 50 per cent of the funds reviewed required work on them!

You can read more about closet trackers on the regulator’s website.

If you hold any active funds within your SIPP, SSAS, ISA or cash, it’s worth checking with your fund managers whether you’re inadvertently invested in a closet tracker, paying over the odds for what might well be a low cost passive fund.

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