Active funds vs Trackers (again...)

jamesd

koru, as a passive managed fund they would have the charges made by an active managed fund but the underlying performance of a tracker fund. The result would be a tracker with high costs, so performance that is worse than a tracker with lower costs.

Bank funds tend to be higher cost versions of standard funds, usually without discounts on initial charge or trail commission. So they would underperform the same fund purchased through a cheaper sales channel. Same for an insurance company reselling a managed fund. It's not completely impossible for them to have low costs, just unlikely.

StevieJ

jamesd wrote: »

I trust that their result is accurate and it's not surprising.

Surely this is only true if they include all the actively managed Dog funds that have now been discontinued, as these are likely to have a severe dampening effect, the same would not be true for discontinued trackers. Are you suggesting that those charts include these?

jamesd

The HL chart ignored them, the Investment Management Association one did include them and tried several alternative assumptions about how the money invested in them would be reallocated after closure.

Funds tend to cease after performance drops and that limits how much money was in them prior to closure and which saw the full effect of any drop. Such drops can be for any reason, from normal market drops to poor management.

koru

jamesd wrote: »

koru, as a passive managed fund they would have the charges made by an active managed fund but the underlying performance of a tracker fund. The result would be a tracker with high costs, so performance that is worse than a tracker with lower costs.

Bank funds tend to be higher cost versions of standard funds, usually without discounts on initial charge or trail commission. So they would underperform the same fund purchased through a cheaper sales channel. Same for an insurance company reselling a managed fund. It's not completely impossible for them to have low costs, just unlikely.

Thanks James. By passive managed funds, you mean funds which claim to be actively managed, yet in practice they mirror the index so closely that they are effectively a tracker? If so, then I agree it stands to reason that if these funds still have the normal management fee of around 1.5%, they are inevitably going to deliver performance which is below average (and below trackers). Therefore, eliminating these funds should mean that you are improving your odds of picking a fund that will perform above average. That would make sense. Is there an easy way to tell which funds are covert trackers?

When it comes to the bank and insurance company funds, the lack of discounts isn't going to change where they appear in the performance tables, because I assume the performance tables are based on the full management charge. The lack of discounts is certainly a good reason not to invest in these funds, but not because they are any more likely to be in the bottom two quartiles than the top two quartiles.

jamesd

Yes, I think that's the definition that dunstonh had in mind and is the one I used. You can look at performance relative to benchmark or the performance charts to check correlation with the performance of a fund that is openly tracking the index. Close tracking would imply a closet/covert tracker.

For the bank and insurance company funds I was thinking of say BigBank FamousFund, where FamousFund is a fund that is available from many fund supermarkets with discounts of initial or annual charges but which is sold at full initial and annual cost by the BigBank or insurance company. The higher costs naturally mean that performance will be worse for the bank version.

Dunstonh might also have been thinking of in-house funds, like in-house trackers, and those might or might not be available at better or worse costs than the competition. Usually the customers of the bank or insurance company have some restriction in what they can buy, so that creates a somewhat captive audience that may pay more than required for whatever index is being tracked. I don't think that this will always be true, since there's nothing preventing a bank or insurance company operating an excellent range of funds if they want to. And some do seem to operate some quite good funds.

koru

jamesd wrote: »

Yes, I think that's the definition that dunstonh had in mind and is the one I used. You can look at performance relative to benchmark or the performance charts to check correlation with the performance of a fund that is openly tracking the index. Close tracking would imply a closet/covert tracker.

I guess that would work. I just used the Hargreaves Lansdown website to create a chart of total return on the FT-SE 100 over five years and I then ran through their list of 858 funds in the UK all share sector and selected some of the ones that sounded like they might be a plain vanilla equity fund. Most of them don't seem to be closely correlated with the index, but I did find a number which seem very close. For instance, I got as far as H. in the alphabet and I found: Allianz RCM UK Equity C,CBF Church of England UK Equity Acc, Ecclesiastical UK Eq Gth A, GAM MP UK Equity Acc, Halifax UK Growth C. Certainly, there is no point buying any of those funds, as you are paying a fee about five times higher than an otherwise equivalent tracker.

I wonder how many closet trackers there are, and what effect it would have on your odds of picking a winner? I suppose that if there were a lot of closet trackers, they would all be perpetually huddled in the second quartile (from the bottom), because they would consistently deliver a little worse than the average return. But if that were the case, you would expect to see pronounced persistence of performance for funds in the second quartile, and the CRA figures don't really seem to show this. For instance, for the UK all companies sector, the percentage of second quartile performance companies that remain in the second quartile going forward over the same period is 29% over 12 months, 26% over two years, 27% over three years, 28% over four years, 27% over five years, 25% over six years and 27% over seven years. In other words, only fractionally higher than the 25% that you would expect if performance is completely random. In other words, even though the second quartile presumably includes all the trackers and covert trackers, between 71% and 75% of the second quartile funds based on performance looking backwards end up in a different quartile over the same period looking forwards. That suggests to me that eliminating the closet trackers probably does not improve your odds much.

Interestingly, having looked again at the CRA report, I would concede that it does seem to show persistence of performance over 12 months. Choosing a company that has performed in the top quartile over the last 12 months seems to give you a likely return over the next 12 months which is between 3 and 5% higher than if you had chosen from the bottom quartile. There seems to be a fairly clear pattern for these short-term figures. This seems to suggest that a good strategy would be to rejig your portfolio once a year, investing only in funds which have been in the top quartile over the previous year. Not all of them will do well, but they will have slightly better odds, as long as you are willing to commit to reviewing on a regular basis. Of course, you would want to make sure that you were only investing in funds where the initial charge is zero or very low after discounts/rebates, otherwise the transaction costs would frustrate the purpose.

However, as was discussed in previous threads, any marginal persistence of performance might simply be a reflection of the risk profile of the fund. Perhaps the funds that tend to lurk in the top quartile do so because they are riskier than the average fund in the particular sector, but if those risks stop paying off they might start delivering very poor performance. Perhaps my proposed strategy simply means that you are investing in the riskiest funds in that sector, which is something you might be happy to do, but you need to realise that is what you are doing.

This brings us back to my original point about Hargreaves Lansdown's figures, that it is important to compare funds with the same level of risk. If you are willing to accept higher risk than a particular index, you can do so by picking a tracker that tracks a riskier index.

Loughton_Monkey

I remain convinced that what is going on behind the scenes is all fairly simple and straightforward.

Firstly, you have the trackers, which would have no 'Manager' as such, because a computer would dictate the correct mix of shares, and tell you what to do with the day's new money. The back room boys would do it.

Now you have the so-called "Managed" funds covering UK Equities. I don't perceive them as 'closet trackers'. I simply perceive them as people who 'think' they have the knowledge. They will load up, say, 40% of the fund with a dozen or so of their "Pet Favourites", and probably chuck the rest around an almost random mix of shares, after having eliminated a few 'dogs'.

So you will favour HSBC, Rio Tinto, and BT..... I will favour Barclays, Astra Zeneca, and Vodaphone....

And so the fund is set up. Feet up on the table. Read through all the 'hospitality offers', select the best, and enjoy them, ensuring that you collar someone in BT to buy you a fat lunch next week to 'discuss our rather large shareholding'. Get the lad in the office to read the FT/Feeds to make sure you're not missing a trick with any of your favourites....

Now personally, I do not call this "Management". This is why such funds will perform +15% more than FTSE, or -15% worse than FTSE. Or anything in between - probably according to a 'normal distribution'. The key difference is that we are all paying an extra 1% or so, for the 'management' in the hope that we pick the top quartile rather than bottom. With tracker, by definition, you are going to get the 'average'.

OK, a bit of simplification to make my point, but generally I am advocating that "The only difference between a managed fund and a tracker - apart from the 1.25% extra cost - is to depart deliberately and significantly from the profile of the tracker - in order to gain a 50% chance of exceeding the tracker, with a consequent 50% chance of underperforming it."

koru

Loughton_Monkey wrote: »

I don't perceive them as 'closet trackers'.

Take a look at a chart of the funds I mentioned above, overlaid on a chart of the FTSE 100. (You can use the Hargreaves Lansdown website to do this. Start with a chart of one of the funds and then add the rest.) You will see that the charts are almost identical. I think that what is happening with these funds is that the staff member who is responsible for fund management is measured on their performance against the index and they are so scared about underperforming the index that they do not dare to depart in any significant way from the makeup of the index. In their minds, they are probably actively managing, but whenever they want to take a bet on departing from the makeup of the index, they do it very timidly, so that whether the debt pays off or not it has little effect on overall performance.

Loughton_Monkey wrote: »

I am advocating that "The only difference between a managed fund and a tracker - apart from the 1.25% extra cost - is to depart deliberately and significantly from the profile of the tracker - in order to gain a 50% chance of exceeding the tracker, with a consequent 50% chance of underperforming it."

I have come across quite a lot of fund managers in my career (although I'm not one myself) and I don't agree with your theory that they are largely allocating their portfolios on an arbitrary basis. However, the funny thing is that under the efficient market hypothesis the conclusion is much the same as under your theory!

Loughton_Monkey

koru wrote: »

Take a look at a chart of the funds I mentioned above, overlaid on a chart of the FTSE 100. (You can use the Hargreaves Lansdown website to do this. Start with a chart of one of the funds and then add the rest.) You will see that the charts are almost identical. I think that what is happening with these funds is that the staff member who is responsible for fund management is measured on their performance against the index and they are so scared about underperforming the index that they do not dare to depart in any significant way from the makeup of the index. In their minds, they are probably actively managing, but whenever they want to take a bet on departing from the makeup of the index, they do it very timidly, so that whether the debt pays off or not it has little effect on overall performance.

Maybe I'm not explaining it too well. I percieve a (say FTSE100) tracker as literally that. It must emulate the same shares in the same ratio as the index. The so called 'managers' I am talking about do not, I believe, try to emulate this even loosely - because they realise the rather distorted weightings (Financial and Oil/Gas) this brings. That's why I don't think they are 'closet trackers'.

I hear what you say about the graphs, but let me ask you to take the FTSE100 companies, and write down 30 of them that you 'fancy'. I'll do the same. We both have different lists, albeit with overlap. Let's wait a year and chart our results, daily. They will both be extremely 'close'. Every single day the FTSE drops, so will your portfolio and so will mine. When it rises, same thing. Just marginal differences in degree.

Unless it has been a particularly good year for Financial/Oil/Gas/Miners, then both of our portfolios will have performed better than FTSE.

koru

Loughton_Monkey wrote: »

Maybe I'm not explaining it too well. I percieve a (say FTSE100) tracker as literally that. It must emulate the same shares in the same ratio as the index. The so called 'managers' I am talking about do not, I believe, try to emulate this even loosely - because they realise the rather distorted weightings (Financial and Oil/Gas) this brings. That's why I don't think they are 'closet trackers'.

I think you are explaining what you are contending perfectly well. I just disagree with you. I think there is a class of supposedly active funds which, empirically, behave much the same as a tracker. They don't just deliver similar overall performance to the index over a given space of time; they track upwards and downwards on a daily basis in close synchronisation with the index, in a similar way to a tracker, but unlike a truly active fund. The difference is that the tracker knows it is passively following the index and it charges a fee which reflects the lower effort involved. The covert trackers probably think they are being active, but they aren't.

Have a look at the 5 year total return charts for a bunch of other UK equity funds overlaid on the FT-SE 100 and you'll see that they diverge quite a lot from the index. Just choose some at random. The funds that I mentioned earlier, however, shadow the index much more closely than most UK equity funds. I think the only sensible explanation is that these particular funds are emulating the index very closely.

However, as I say, we don't differ much in our conclusions, which is that there's little point investing in these funds. So I am not sure it is worth debating a point that doesn't seem to matter. (Although it is quite interesting!)

You might be interested in the following academic study. It relates to US funds, but it concludes that many active funds closely mirror the index and the truly active funds are the ones that are most likely to beat the market:
http://rfs.oxfordjournals.org/content/early/2009/08/06/rfs.hhp057