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Adviser workshop: how to spot a closet tracker

How can advisers spot a 'closet tracker' fund? That's the question our investment editor Shunil Roy-Chaudhuri (pictured) put to advisers in this week's edition of adviser workshop.

Keith says...

It is possible to pay for active management and end up having passives. This issue has been going on for years. Even in the with-profits days of the 1970s and 1980s.

It requires careful monitoring. As long as charges are checked and comparisons are made, it is reasonable, but not easy, to hold proper actively managed funds and avoid closet trackers.

It is far easier than ever to access charge comparisons. Press a few buttons and away you go. You can select a range of trackers from a sector and look at their asset allocation models. The sector benchmark should reveal typical allocations. You can then see if funds are effectively within a few percentage of following the index. These could be closet tracker funds.

We like bespoke boutique investment managers, which usually follow their own mandates rather than following indices.

I actively seek less benchmark-constrained managers. On our list of active managers we would consider building into our programmes are: Hermes, Barings, Cavendish, Jupiter, and Lazard. We also rely on Steve Williams, director of Cormorant Capital Strategies. He sits on our investment committee and looks into these issues all the time.

Top quote: 'Technology has made it easier for advisers to interrogate funds. Systems now let you compare the performance of actively managed funds, benchmarks and tracking funds.'

Top tip: Look for managers less concerned with benchmarking, and monitor carefully.

Keith Churchouse is director at Chapters Financial

Keith says...

It is possible to pay for active management and end up having passives. This issue has been going on for years. Even in the with-profits days of the 1970s and 1980s.

It requires careful monitoring. As long as charges are checked and comparisons are made, it is reasonable, but not easy, to hold proper actively managed funds and avoid closet trackers.

It is far easier than ever to access charge comparisons. Press a few buttons and away you go. You can select a range of trackers from a sector and look at their asset allocation models. The sector benchmark should reveal typical allocations. You can then see if funds are effectively within a few percentage of following the index. These could be closet tracker funds.

We like bespoke boutique investment managers, which usually follow their own mandates rather than following indices.

I actively seek less benchmark-constrained managers. On our list of active managers we would consider building into our programmes are: Hermes, Barings, Cavendish, Jupiter, and Lazard. We also rely on Steve Williams, director of Cormorant Capital Strategies. He sits on our investment committee and looks into these issues all the time.

Top quote: 'Technology has made it easier for advisers to interrogate funds. Systems now let you compare the performance of actively managed funds, benchmarks and tracking funds.'

Top tip: Look for managers less concerned with benchmarking, and monitor carefully.

Keith Churchouse is director at Chapters Financial

James says...

We avoid closet trackers by identifying truly active fund managers. We identify sources of manager skill and start with quantitative research. We look at performance characteristics, such as alpha, the Sharpe ratio, and the Traynor ratio.

R-squared is another good quantitative measure. Anything above 90% to 95% means the bulk of the performance is driven by the index. We look for a low R-squared.

We review past performance over several different periods, in addition to maximum drawdowns and maximum gains. We want active managers who protect on the downside and reposition on the upside. 

Once we decide the asset allocation and filter down the sectors we are interested in, we drill down into the individual sector itself. We apply the quantitative filters mentioned above and then look at the qualitative side. We look in more detail at the investment process and the fund manager themselves.

We look at how many holdings are in the fund. A small, high-conviction portfolio of 30 to 40 stocks will not track the index. That is a good way to identify a truly active fund manager. 

Top quote:

'We look for an unconstrained approach. So the manager can impelement the process as they wish, letting their skill take hold. We want most of the performance to come from stock selection. This helps determine whether a manager's returns are from luck or skill.'

Top tip:

Look at different performance characteristics and over different periods of time. 

James Bailey is investment manager at property wealth management

What Twitter thinks:

New Model Adviser® investment editor Shunil Roy-Chaudhuri asked the Twittersphere about avoiding closet tracker funds. Here are the responses he got:

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