UK fund managers are often labelled as closet trackers due to the similarity of their performance re...
UK fund managers are often labelled as closet trackers due to the similarity of their performance results with the FTSE All-Share indices. This phenomenon has developed primarily as a result of risk controls but the lack of liquidity in the UK market and compliance requirements are other contributors to this ever-increasing trend.
Homi Colah, partner of Apax Partners & Co and manager of the Artemis Momentum hedge fund, said investors expect absolute performance. He said if relative performance is the only criteria important to investors, they should invest in a tracker fund, as this would remove individual stock risk.
According to David Hambidge, fund manager of Premier's fund of funds product, Premier Selector Growth, there is a place for both actively managed funds and quasi-trackers in the market. He said the quasi-trackers are suitable for the risk-averse investor seeking better performance than that offered by a tracker product.
Hambidge said any fund that can consistently outperform the market by 2-3% annually after costs is worth holding. The downside is that there is no guarantee this will be the case.
UK funds known for their preparedness to move away from the benchmark included Credit Suisse, ABN Amro and Artemis. Another notable name is Perpetual, although it has underperformed the market over the past year.
Hambidge said many of these funds have demonstrated strong performance during a period of little movement in the market.
The Credit Suisse Growth Fund is up 21.5% in the year to 26 July offer to bid, Artemis UK Growth is up 49.9% and ABN Amro UK Growth is up 66.5%. Perpetual UK Growth is down by 2% over the same period. One of the UK's best known index funds, the Virgin UK tracker, is up 6.7% over the same period with the UK All Companies sector average of 299 funds running at 6.1%. The FTSE All-Share rose by 8.42% over the same period.
Other fund managers prefer to be more risk averse at both a stock and sector level. Investment houses impose risk control measures on the extent of a bet that a fund manager can take. For example, a positive or negative bet on a sector might be market weighting, plus or minus a certain percentage. The same often applies at a stock level.
Hambidge said: "Some fund managers, even if negative on some of the bigger index players like Vodafone or BP Amoco, will still hold a large chunk of these stocks in their fund to guard against the risk of being left behind if that company surges ahead.
Colah said: "Often there is no reason to invest in a certain sector, but fund managers have to have a certain toe-hold to avoid a business risk that the fund management group doesn't want to take should the sector suddenly push ahead."
He said it must be asked whether the fund manager is guarding against his own risk or in fact presenting a risk to the investor's potential for absolute returns.
In addition to internal risk constraints, fund managers must abide by the compliance requirements of regulators. So many active fund managers are restricted from taking the bets they would otherwise like to.
Such unit trust compliance regulations include a requirement to hold at least 85% of the portfolio in market instruments, even if the fund manager is bearish on equities and it would prefer to hold a higher proportion of the fund in cash.
John Kelly, investment director at BGI Funds, said in many cases there are explicit strategies whereby the fund manager takes a clear benchmark and tries then to beat it, in the knowledge that the benchmark generally beats most actively-managed funds over the longer term.
He added: "Proper risk control is far more than just looking at approximate stock and sector weightings; fund managers have to understand how groups of stocks with complex inter-relationships react together if they are to add value in a risk-controlled way."
An unrelated factor that inhibits the ability of some fund managers to take larger stock bets is the sheer size of some of the bigger portfolios. This is exacerbated by the lack of liquidity in the UK market. The size of larger funds is hampering performance, particularly in volatile market conditions, such as the recent slump in the technology, media and telecoms sectors.
The fact that larger funds are struggling to perform is reflected in their performance statistics. The £1.06bn Prudential UK Growth fund is ranked 204 of 233 funds in the UK All Companies sector, offer to bid in the three years to 26 July, and 229 of 285 funds over one year.
The £3.7bn Mercury (Merrill Lynch) UK Equity fund is ranked 143 out of 233 funds over three years and 127 out of 285 funds over one year.
The £1.07bn Schroder UK Enterprise fund is ranked 198 out of 233 funds over three years and 200 out of 285 funds over one year. The £1.1bn Perpetual UK Growth is ranked 209 of 233 funds over three years and 227 out of 285 funds over one year.
This is because bigger funds have difficulty reducing or adding to their holdings. For example, if a £1bn fund wanted to reduce one of its holdings by 1%, then it would have to dump £10m of stock on the market. Colah said: "Artemis can take focused bets on sectors and stocks because we are small. However, when you are managing £300bn, you unfortunately become the market. You don't have any recourse to sell and the market knows your position before you arrive at it."
Hambidge agreed, saying larger funds cannot be as nimble and cannot take advantage of some situations like smaller funds in the peer group. He added: "The strategies of bigger funds must be different to those of small funds, but the large market cap of many companies means that you can still hold a portfolio in the FTSE 100 which is miles away from the index.
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