Last week I wrote about the mystifying continued existence of funds that pretend to be actively run, with charges to match, but which in reality merely track an index.
I mentioned a simple measure called 'active share' (AS), which can tell us at a glance whether or not a manager is doing the kind of stock selection we should be happy to pay for. I asked you to send in suggestions of who is walking the walk.
The response has been almost overwhelming. You sent me white papers on the matter; your lists of the problems with AS; lists of your own criteria for choosing funds; lists of the funds for which you act as public relations managers; some suggestions of alternative measures to AS; a few quibbles with the data; and many kind invitations to take the discussion further over lunch, coffee or dinner (sadly, I can't accept all of those, but you'll soon be able to bid for lunch with me in the FT's charity auction).
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So thank you for all of that. The only thing that none of you sent was any defence at all of the nation's closet tracking industry. That's interesting in itself. Nobody, it seems, is willing to defend the indefensible.
On to your responses. Will Low, now at Nikko Asset Management, sent me a nice paper written when he worked at Scottish Widows Investment Partnership, which backed the research I mentioned last week.
It has "not to be disseminated to the public" written firmly at the bottom of the title page, but as MoneyWeek'sreadership clearly isn't the ordinary public, I think we are safe to pass the key bits on to you.
According to Low's work, the best funds have a high AS (so 90% of the portfolio differs from the index), but not too much concentration in any particular sector, currency or commodity. That way, the returns come from good stock picking rather than taking 'factor risk'.
Mr Low, along with several other readers, also pointed to benchmark problems: if the benchmark isn't the right one in the first place, or the portfolio is significantly different in asset allocation to the index, the idea of AS can be meaningless.
You could, for example, have a very high AS but still be entirely passive if you benchmarked to the FTSE 100, but divided your portfolio between the shares that make up the FTSE 250 and a bond fund. Who needs that?
Overall it seems that there are five questions we should ask about a fund. Does it have a high AS (at least 80%, preferably 90)? Is it limiting its risk to stock picks? Is its underlying benchmark the right one? Are the fees at the right level? Do its managers have a record of good performance (at least five years)? The answer to all these questions should be yes.
On to fund recommendations. These are some that I have come across, that you have come across, that are run by managers who read this column (or the PR people they pay to read this column).
First up is Fundsmith, whose founder is also an FTMoney columnist. Performance has been strong since launch (though it does not yet have five years of performance history) and readers seem to like it. The fund's active share is in the mid-90s.
Next is the Magna Emerging Markets Dividend fund, which comes with an AS of 91.5% and excellent outperformance since launch four years ago.
Then pretty much all the funds run by Guinness. I've mentioned both the Guinness Equity Income and their Global Innovators Funds here before. They don't have long performance records, but that is nicely reflected in the very low introductory fee of 0.25%.
It is also worth noting that they both have an AS of over 94%. The same goes for almost anything from Baillie Gifford (disclosure: I am a non-executive at one of the investment trusts they run, which has a pleasing AS of 94%).
Hermes also runs a suite of equity funds, which have AS ratings above 80%, and all of which have beaten their benchmarks nicely.
Next, a fund from a small boutique, Everlode Income. This has a slightly lower active share at 76%, but it is still small, has performed well over the past five years and comes with a fee (0.75%) that appears reasonable.
Other suggestions for you to look at include the Discretionary Unit Trust run by Simon Knott, the Thistledown Income Fund, and Heronbridge UK Equity.
Finally, a mention for funds of funds. The layering of fees here is almost too much for me to bear. But Simon Evan-Cook of Premier Asset Management, who did some of the research I referred to last week, points out that many of the best funds (those with high AS and good performance records) are closed; their managers, wanting to stay reasonably nimble, are taking no more money.
That means ordinary investors can't get access to the likes of the Pruisk Asian Equity Income fund unless they buy into a fund of fund that already holds it.
Mr Evan-Cook naturally thinks you should buy his fund to achieve that. I'd be more easily convinced if multi-manager funds had fewer holdings. But I do still have to tell you that his Premier Worldwide Growth fund has outperformed its index (after fees) since 2010.
Finally, a word on finding out the AS of any particular fund. As Judith Evans reports, many fund managers and distributors say they would be happy to incorporate active share into their promotional literature or search functionality. We'll see.
In the meantime, if you want to know a fund's active share, call them and ask for it. If you do so and end up establishing that the active share on any one fund is relatively low say 60% you might write to the manager suggesting that he should be paid tracker-style fees (say, 0.1%) on the closet tracker part of his portfolio and his active management fees only on the remainder. That might prompt some action, or at the very least some thought.
This article was first published in the Financial Times.
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