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Fund selectors’ ‘closet trackers’ survival guide

Amid widespread investigations into ‘truly active’ management, Citywire Selector spoke to leading names in Europe to hear how they avoid passive proxies.

Keeping tabs on closet trackers

The concept of ‘closet trackers’ – funds marketed as active which closely mimic the benchmark – has once again returned to the fore, with watchdogs and consultancies keeping a close eye on whether the biggest fund houses are delivering value for money in alpha generation or if mis-selling is becoming more prominent.

In a comment piece for Citywire Selector’s sister site Modern Investor, Invesco Perpetual’s Andy Hall and Stephen Anness argued that contrarian investors can stand out if this level of consensus-led investing persists, but what does it mean for those picking the fund managers?

Citywire Selector spoke to three leading asset allocators from across Europe to see how they cut through the closet trackers to unearth truly active managers for their portfolios.

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Concentration is key

For Florian Gröschl, multi-manager at Austrian group ARC, the way to ensure that your fund selection is avoiding passive players posing as active managers is to keep it concentrated.

The important thing in fund selection is, as in every other business where it ends up in selecting a product amongst an infinite list of fairly similar ones, first to know what you want and second to be able to analyse what you get.

If you are searching for market exposure, go for futures or ETFs, avoid complicated engineered products and funds that are charging fees for giving you passive exposure to markets.

But how you distinguish active managers from those who make you think they are but aren’t? In terms of ratios basically tracking error and active share are the numbers to look at. The higher, the better is the rule of thumb.

In my view the ultimate criterion to measure the degree of being active in traditional long only convictional fund management is portfolio concentration. It seems to be very hard to hug your benchmark with only 30 to 50 names in your portfolio.

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Savvy selectors can spot poor performers

While the problem is a real concern for retail investors, it would reflect poor practice if professional investors are also suckered by this trend, according to Pierre Bellot, fund selector at Invesco in France.

Closet trackers as a discussion topic are gaining visibility in the asset management industry. Yet it is important to be careful on the implications, as the main aim of the campaign is to make sure that non-professional clients are protected against unfair practices.

For a professional investor, it is not a cause for great concern, mainly because while the statistical characteristics of a closet tracker are difficult to standardise, it is very easy to spot a fund that is constantly reproducing the benchmark performance less the fees: the relative performance must be steadily but constantly negative to a level equal to the management fees of the strategy.

But as the investment landscape is shifting fast it is even easier to avoid the caveat: focusing beta exposure on passive investment and carefully selecting active investment strategy that delivers either meaningful market bias or an exposure to an asset class that provides an improved risk adjusted return holds the key in order to avoid paying high management fees for beta return.

A careful analysis of the process, of the portfolio performance over time and of the consistence between the fund manager’s speech and empirical results should protect a sensible professional investor against this issue.

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Trackers getting found out

Fondaco’s Giuliano Anselmo believes the question of closet trackers is not becoming a more pressing concern but receiving a last airing before it becomes a forgotten trend.

Actually I don’t agree with the idea of closet trackers becoming more and more prominent, I think it’s probably the other way round. Of course there are still many examples of that issue, but today clients should have both the instruments and a healthy scepticism when analysing a strategy.

I think this was much more of an issue in the past, but things changed after the Petajisto’s paper on active share: after that, even less sophisticated and aware investors started to pay increasing attention to concepts like 'cost per unit of alpha'.

Though I support decisions to tackle misbehaviour, I also think they might be a little late, as the industry is already penalising closet trackers. This is through favouring either openly passive and quasi-passive strategies, or very active risk-takers, while they are just hammering in the last nails on closet trackers’ coffin.

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