March 12, 2018

Monday Morning Memo: A Brief View of Measures to Identify “Closet Trackers”

by Detlef Glow

A topic widely discussed in the European fund industry is actively managed funds that seem simply to follow an index without adding value for investors, while the management company charges fees for active management—so-called closet trackers. For me it is clear that active funds should add value to investors, either by reducing the risk attached to the market or by generating outperformance compared to their index. In this regard, I agree with the current investigations into these funds by the authorities of some European countries, since retail investors—especially—need protection.

But the point I don’t agree with is how the activity of a portfolio manager should be measured. It is mainly done with the so-called active share—a ratio that measures how widely the constituents of a portfolio differ from the constituents of its respective index. The measure is heavily dependent on the market index used for the comparison. Therefore, the fund promoter can influence the results by the choice of market index.

In addition, it needs to be said that a high level of activity is not a guarantee of outperformance or of lower risk, since a transaction by a fund manager does not automatically lead to outperformance. The fund has to pay a fee for every transaction by the fund manager, reducing the performance of the fund. Therefore, I would personally prefer a fund with a low active share and high outperformance over a fund with a high active share that delivers low outperformance or even underperformance. That said, I personally think the active share is quite overvalued for predicting the possible outperformance of a fund. In this regard, I would recommend investors, advisors, and authorities use other measures such as the information or Sharpe ratio and the overall performance in their evaluation of whether a fund is worth its fees.

The views expressed are the views of the author, not necessarily those of Thomson Reuters.

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