Tracking down the real talent with ‘active share’

Neil Woodford: outing the closet trackers

Neil Woodford is undoubtedly the best-known investment manager in Britain. So the news this week that his firm has begun publishing the ‘active share’ of his fund could mark the start of an overdue shift in the UK fund industry.

For the majority of investors who have never heard of active share, this may not seem a big deal. So to summarise quickly, active share is a statistic that measures how an investment portfolio differs from the index that it is benchmarked against. An active share of zero means that the fund holds exactly the same stocks in exactly the same proportions as the benchmark. An active share of 100 means it has nothing in common with its benchmark.

The reason why active share is useful is that fund management is plagued by “benchmark huggers”, or “closet trackers”. These are funds that claim to be actively managed and say they aim to beat the market, but in reality stick closely to their benchmark, while still charging high fees. Active share provides a tool to help investors spot and avoid these funds: essentially anything with an active share of less than 60% is a closet tracker. See here for full details of how active share works.

Woodford is not the first manager to begin publishing his active share statistic. Neptune also began doing so this week. Threadneedle already includes active share on the versions of its fund factsheets aimed at professional investors, while Baillie Gifford says it intends to start doing so next month. So what’s behind this trend?

One of the welcome consequences of the ban on financial advisers from receiving commissions from fund sales is increasing scrutiny of fund costs. Previously, equity funds charged an annual management fee of around 1.5%, of which about half was kept by the fund firm and half kicked-back to the adviser and the platform they used. Fund firms concentrated onpromoting their funds to advisers and there was surprisingly little competition on fees.

Now that charges have become more transparent and investors are more aware of them, there is pressure on fees. This is being helped by the popularity of low-cost exchanged-traded funds (ETFs – see below). So fund managers now need to defend the value of what they do – and one way of doing that is to demonstrate that they are genuinely running active funds, not just closet trackers. Hence the value of publishing their active share.

That said, active share is not perfect. First, the fact that a fund has a high active share doesn’t mean it will beat the market. It means the manager is taking decisions that make the fund different from the benchmark – but they may be bad decisions. Second, active share involves measuring a fund against a benchmark – and that depends on the right benchmark being chosen.

A manager who is benchmarked against the FTSE 100 but puts lots of smaller stocks in the portfolio may have high active share and perhaps beat the index – but that could be down to a favourable choice of index (maybe they should be benchmarked against the FTSE 350). So investors need to keep this in mind. Nonetheless, it’s good that firms are finally starting to publish this information. Hopefully, the rest of the industry will be forced to follow.

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