Large Cap Funds

How active is your fund manager?

Investors are wasting millions of pounds in fees paying for actively managed funds that do little more than mirror the FTSE index. Many of the funds – dubbed "closet trackers" – are offered by major banks and insurers and charge investors up to 2pc a year on their investments when they could get similar results from a tracker fund that charges a tenth of the fee.

UK equity funds from Scottish Widows, Halifax, Prudential, Santander and Henderson have been found to have at least 90pc correlation between their top 10 holdings and the FTSE 100's biggest companies. The funds have nearly £11bn under management between them, with up to 48pc of their entire fund invested in the top 10 UK megacaps.

Steve Wilson of Alan Steel Asset Management said he was not surprised at the correlation. "I used to work at an insurer, and they are known for being the worst – you are paying 1.5pc a year for a tracker," he said.

"A lot of these funds will hold mostly institutional money and pension funds, which is not reviewed as often as private investors' choices, but that does not mean managers should get away with it."

James Anderson of Baillie Gifford, who manages the £1.9bn Scottish Mortgage Trust, said: "If you [the fund manager] don't underperform on one year you won't get sacked, so you do what the index tells you."

He added that if Scottish Mortgage had held on to its 10 biggest stocks in 2001 – led by Royal Bank of Scotland and Lloyds – it would have been "catastrophic".

Not surprisingly, "actively managed" funds that appear to do little more than follow the index deliver similar performance.

Brian Dennehy of Dennehy Weller & Co looked at the correlation between a handful of UK equity funds and the FTSE 100. Correlation is not about performance but about direction, so a highly correlated fund would falter when the FTSE fell and do better when the FTSE rose.

Mr Dennehy said that even if a fund was highly correlated with the FTSE, it would not matter if it outperformed the index. However, high correlation and a similar return – or even a worse return – to the FTSE was the mark of a closet tracker.

Since March 2009 the FTSE 100 has risen by 67pc. After fees, Santander's UK Growth fund has also returned 67pc, Halifax UK Growth and the Pru UK Growth fund have returned 64pc and Scottish Widows UK Growth has returned just 54pc.

T Rowe Price Small Cap Stock Fund | Small-Cap Mutual Fund Inflows ...

Investors tired of miniscule returns from their money market accounts and intrigued by small-cap funds in a variety of industries pumped more than $11.3 billion into diversified U.S. equity mutual funds in the first quarter and more than $14.8 billion into global sector funds.

This spike in mutual fund inflows was especially pronounced among small-cap funds, according to data SP obtained from Lipper, as all three small-cap peer groups garnered inflows in excess of $1 billion in the first three months of the year with small-cap core and small-cap growth funds receiving inflows of $3.6 billion and $1.6 billion, respectively.

Meanwhile, large-cap core funds and large-cap value funds took a hit over this same period, losing $8.8 billion and $1.1 billion, respectively, in capital as investors continued to favor so-called “risk on” trades in the belief that these smaller firms’ earnings will outpace the expected growth of their larger brethren.

But this recent infatuation for small-cap funds will likely reverse itself, according to SP’s equity research analysts, as the current economic cycle matures and large-cap funds become more compelling and competitive.

“As we go further into the third year of this bull market as the economy continues to recover, historically we’ve seen that large-cap stocks and funds do better,” said SP mutual fund analyst Todd Rosenbluth. “As a bull market matures, more stable companies benefit more. If we see gains in large-cap stocks, which we think we’ll see, we’ll see more money flow back into these large-cap funds.”

Rosenbluth said the strong performance of many small-cap growth and small-cap core funds is owed largely to investors — new and old — putting their money into stocks and mutual funds that have performed best most recently.

“Part of this growth is not necessarily for the right reasons,” he said. “When investors are looking to put money into the market, they’re often following the trend and what worked in 2010, in many cases, were these small-cap stocks and funds. However, these small-cap stocks are more volatile than large-caps so as someone much smarter than me once said, the trend is your friend until it isn’t.”

By sector, commodity and natural resource funds enjoyed inflows of more than $6.2 billion and $3.7 billion, respectively, in the first quarter as oil prices continued to spike and investors hedged against looming inflation concerns by pushing gold to an all-time high of $1,500 an ounce.

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