If I asked most investors/pension holders what they thought was happening inside their invested money, the answers I’m sure would all correlate.
You pay money to have your hard-earned cash managed to minimise risk and maximise return and you expect that.
Unfortunately, that is not what happens all the time and investors are estimated to be losing out, into the Billions.
There are two key points for you to look out for: Poor management, where a manager simply allocates cash to different pots and holds for long periods of time; closet tracking where a fund is literally mirroring a stock market index, and charging for active management.
Let’s not become too hung up on costs in isolation, as we all know a cynic knows the cost of everything and the value of nothing. However, if you pay for a Ferrari and receive a Shetland pony, you might have cause to be annoyed.
Fortunately, the difference between the Ferrari and pony is pretty evident, but investors will find it very difficult to assess if their funds are indeed closet trackers.
A manager should buy the very best stocks, bonds, property funds, but also ensure they are not correlated together i.e. you have a group of stocks all in the same area. By having negative correlation, you have protection from surges or falls in one specific area. The manager should then be actively managing thereafter, taking gains, moving between markets, stocks, and sectors to keep your portfolio balanced and in the correct risk.
Sadly, that often doesn’t happen, and many investors ride into the sunset on their expensive Shetland.
The Financial Conduct Authority (FCA) has cracked down on the reasonably obvious closet trackers where they have identified investment funds have been simply tracking an index but charging for active management.
This week Henderson were fined £2.7 Million for overcharging clients in such closet trackers. They received a 30% discount on the fine for agreeing to resolve the matter.
4,700 customers were disadvantaged by a change in the active management of two funds which the FCA believe didn’t treat customers fairly.
This followed an order last year from the FCA, for fund managers to return a staggering £34 Million in overcharged fees as the FCA cracked down on closet trackers.
In an investigation into closet trackers, 64 of 84 funds that were marketed as actively managed market leading funds, were nothing more than a tracker. They were ordered to change their marketing material and the companies pledged to compensate their customers.
Some believe it to be a drop in the ocean with figures close to £6.6 Billion estimated as a more accurate analysis of overcharging.
A tracker simply tracks the stock market index using technology and you can typically pay between 0.05% to 0.30% for such ‘expertise’, whereas some of the closet trackers are charging between 0.75% to 3% per year.
Not for one second am I stating that a passive tracker is the right idea because of the cost (that’s another article), but to pay 3% for a fund that is doing just that is completely unacceptable.
In the absence of a fund manager treating you fairly and tagging their funds as a tracker, how can you tell if you have one?
There are a few different measures to consider, and your Independent Financial Adviser can help you.
One measure is a called an active share which analyses at any given time how much a fund differs from its benchmark (index) in terms of the companies it holds and the allocation to them.
Another is a financial measure called R squared, which analyses how much of a fund’s returns are derived from movements in an index.
These are often not used, because understanding them and what they mean in the context of investing is quite complicated, but a good financial adviser will be able to explain and decide quickly.
Whilst the FCA are cracking down, in the meantime, your capital could be hit by a lack of active management or charges that are completely unnecessary.
About the author
Peter McGahan is Chief Executive of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.