The magic number that could earn you a FORTUNE
Keeping investment costs down is always important, whereas in turbulent times when most portfolios fall, it’s absolutely integral to preserving your wealth.
One way to determine if you’re getting good value for money is to look for a little-known number known as active share.
Investment experts use it as an indicator of how hard their fund managers are working for them. Then, if they find that their fund managers don’t justify their fees, they can ditch them for a cheaper option. It is a tool that ordinary investors can also use.
Indicator: One way to tell if you’re getting good value for money is to look for a little-known number called active share.
Beware of Closet Trackers
There are two main approaches you can take when investing. You can either buy an active fund, which is a selection of investments handpicked by an expert fund manager. Or you can opt for a passive fund, which buys all investments in a particular index. For example, a passive fund that tracks the FTSE 100 simply buys all 100 UK listed companies in that index.
Active funds tend to cost more because you’re paying to have someone screen your investments. The hope is that their specialist knowledge will enable them to spot the best investments and outperform the index to which they are benchmarked.
But this is where investors need to be careful. Sometimes active fund managers simply put together a portfolio that almost resembles the index they’re trying to outperform.
These funds are called closet trackers – because they disguise themselves as active funds but in reality do nothing more than match their benchmark.
“Given the extra fees charged by actively managed funds, there is little value in investing in a fund that consistently resembles the benchmark it is trying to beat,” says Ryan Hughes, Head of Partnerships at investment in AJ Bell.
A new analysis from investment platform Interactive Investor has revealed that 10% of all investment funds are ‘closet trackers’.
The power of the active part
Active share is a measure of the difference between a fund’s portfolio and its benchmark. It is expressed as a percentage. So if, for example, a fund has an active share of 40%, 60% of its holdings will be the same as a passive fund that tracks the same benchmark.
Jason Hollands, managing director of wealth manager Evelyn Partners, says: “Active share is basically how much a portfolio differs from its benchmark.
“A high active share is therefore an indication that the fund is taking bolder positions than the index in the hope of outperforming investors.”
How to choose the right number
Generally, if you are paying for active fund management, you should expect high active share. Hughes says funds with an active share of more than 80% should be considered “sufficiently different from the benchmark.”
He adds: “Below, investors are probably better off investing in a cheap tracking fund.” Rob Morgan, investment analyst at broker Charles Stanley, believes an active share above 70% is “a good sign”.
“There’s no right or wrong number,” Morgan says. “But we like to see a high number to demonstrate the differentiation of an active investing approach.”
James Yardley, research analyst at investment group Chelsea Financial Services, says investors should consider active share over time.
“There may be times when good fund managers step back and reduce their active share to 60% due to market conditions, but then they may increase their active share to as much as 80% in the future,” explains- he.
Ask your broker for the figure
Some fund managers, such as Edinburgh-based Baillie Gifford, disclose their active share on their monthly factsheets, but others do not.
“If I were cynical – which I am – it’s no surprise that fund companies that publish this ratio tend to have a high active share,” says Kyle Caldwell, collectives editor at the platform. Interactive Investor investment.
“Fund companies are not required to publish this ratio, so it is not widely available. But it should be.
Yardley in Chelsea suggests asking your fund broker if the active share doesn’t appear on your fund’s information sheet. You can also perform a few quick checks that should give you an idea if a fund has a low or high active share:
- Check fund performance: If a fund closely tracks the performance of its benchmark, it may be a hidden tracker. If it has good and bad years relative to the index, it likely has a high active share.
- Check the number of holdings: a concentrated fund of 20-40 holdings is likely to have a high active share. Yardley says a fund with more than 150 holdings is often a red flag for a closet tracker.
- Examine the top ten holdings: If the list of top ten stocks held in the fund is simply a list of familiar stocks, the active share is likely to be low.
Save on fees with cheaper trackers
If you find that some of the funds you hold have a low active share, replacing them with less expensive tracking funds could save a lot of money while producing similar investment results.
Hughes says investors can expect to pay around 0.85% per year for most closet trackers. Replacing them with cheap passive funds charging just 0.07% a year, like the iShares FTSE 100 tracker, would save around £150 in fees each year, says Hughes. This is based on an investment of £20,000.
Hughes adds: “These savings are significant and, in the long run, will make a huge difference to investors’ wealth.”
The experts’ choice of low-cost funds
There are several inexpensive tracker funds you can use to replace your wardrobe trackers. In addition to the iShares FTSE100 tracker, Hughes suggests the Fidelity Index World fund, which has ongoing charges of 0.12% per annum and gives exposure to the world’s biggest companies. Last year it fell 2.9%, but it has risen 34% over three years.
A word of warning
It’s worth remembering that while active share is a useful metric, it shouldn’t be used on its own to gauge a fund’s value. You should also not assume that a high active share automatically equates to outperformance of investments.
“It’s an ingredient in the mix,” says analyst Morgan at Charles Stanley. “Active share doesn’t do anything good or bad. It’s just something to consider in your evaluation of an investment fund.
“A high active share does not mean that an investment fund will outperform,” agrees Ryan Hughes. “All it’s telling you is that the performance is likely to be different than the index it’s trying to beat. It could be better, but it could also be worse.
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