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How active is your fund (and should you care?)

Debate is raging over whether or not actively managed funds should be forced to declare their active share figures. But what is active share and should it matter to you?
February 18, 2015

Active funds are under pressure to publish their active share figures amid accusations that many are actually 'closet trackers', charging high fees to passively track a benchmark.

Halifax UK Growth C (GB0031810210), Scottish Widows UK Growth A (GB0031741738) and Santander PF UK Equity A (GB0002795101) have been named in an SCM Private report, which accused them of misleading investors by replicating their benchmark indices instead of using their expertise to beat the market.

Using active share data, which calculates the difference in make-up between a fund and its benchmark, SCM claimed that more than a third of UK funds were essentially index funds. It is lobbying the Financial Conduct Authority (FCA) to force all managers to publish their active share figure and has pledged to commence legal actions against a host of funds for mis-selling. SCM hopes to follow the Swedish Shareholders' Association, which brought mis-selling allegations against Sweden's largest fund house, Swedbank Robur, on behalf of 2,500 investors.

Meanwhile, active fund houses Neptune, Threadneedle and Woodford Investment Management have waded into the debate by publishing the active share of their equity funds.

 

What is active share and is it a good metric to use?

Active share is calculated as the ratio of a portfolio that differs from the benchmark. It is measured by taking the sum of the absolute value of the differences of the weight of each holding in the manager's portfolio versus the weight of each holding in the benchmark index and dividing by two.

That means that if a benchmark index included just one stock and a manager invested only 50 per cent of the portfolio in it, the active share would be 50 per cent. In this sense the active share number in this example is essentially saying that 50 per cent of the manager's portfolio differs from the benchmark index.

The term 'active share' first came into popular usage in 2006 following a report by Martijn Cremers and Antti Petajisto of the Yale School of Management. The researchers looked at the performance of 2,650 all-equity US mutual funds between 1990 and 2003 and found that funds with an active share of 80 per cent or higher performed best.

SCM Private's report looked at 154 retail UK equity funds and found that the 10 funds with the lowest active share underperformed the market by an average of 2.8 per cent.

 

Active vs passive - and what about performance?

Investors choose active managers in the hope that they will use their expertise to choose the best stocks and be able to beat the market, offering high returns even when times are bad. Perhaps the most galling aspect of the 'closet tracker' phenomenon is when an active fund both fails to take an active approach to investment and also fails to outperform the benchmark as it sets out to do, as is the case for several mentioned in the SCM report.

Halifax UK Growth C had an active share of 18.5 per cent in 2014, compared with 11.9 per cent in the five years to the end of 2013, while Scottish Widows UK Growth A reported an active share of 21.4 per cent.

With an ongoing charge of 1.50 per cent and 1.61 per cent, respectively, both are more expensive by far than comparable passive funds. The argument for paying the price for an active tracker is that these funds beat their benchmarks, but those two both failed to beat the FTSE All-Share index over one and five years by significant margins.

By contrast, the Vanguard FTSE UK All Share Equity Index Unit Trust (GB00B3X7QG63), at a charge of 0.08 per cent, has lagged behind the FTSE All-Share index by less than it charges in fees each year with only one exception, according to Morningstar.

Fidelity Index UK Fund A-Acc (GB0003875324) has also succeeded in achieving minimal tracking difference – the amount of variation from the FTSE All Share benchmark – since inception, while charging only 0.09 per cent.

The funds with the highest active share according to SCM were Unicorn UK Income B Inc (GB0031217937), at 97.4 per cent - way over the average active share of 64 per cent - and PFS Chelverton UK Equity Income A Inc (GB00B1FD6244) at 96.6 per cent. Both funds have beaten the FTSE All-Share by significant margins over the past five years.

However, a high active share means only that the manager's choice diverges from the benchmark make-up and not that the manager is guaranteed to offer high returns. Fidelity UK Growth (GB0003878443) had an active share of 84.9 per cent in 2014, making it highly divergent from its benchmark - but it returned less than the FTSE All-Share on a five- and three-year cumulative basis.

 

Cumulative performance and active share of mentioned funds

Active share 2014 (%)Ongoing charge (%)1-month performance (%)3-month performance (%)6-month performance (%)1-year performance (%)Cumulative Return Feb 2010 to Jan 31 2015 (%)
Halifax UK Growth C18.51.53.834.391.787.0952.79
Scottish Widows UK Growth A21.41.613.876.061.234.0740.74
PFS Chelverton UK Equity Income A Inc96.61.755.607.503.802.60140.10
Unicorn UK Income B*97.40.814.116.982.400.37153.66
FTSE AllSh TR GBP2.623.932.527.1161.51

Source: Morningstar, 13.02

*Source: Bestinvest data from 16.01-16.02