It’s all coming out now about closet trackers

Stocktake: Funds sold as actively managed may actually closely follow benchmarks

Some of the biggest names in the European fund management industry may be selling closet trackers, according to campaign group Better Finance.

Closet trackers refer to high-fee funds that are marketed as actively managed but which actually closely follow underlying benchmarks. Major asset managers such as JP Morgan, Fidelity, Amundi and Schroders were just some of the companies selling funds with an active share of under 60 per cent and a tracking error of less than 4 per cent, said Better Finance.

The excuses provided were weak. JP Morgan, for instance, said a high active share is “no guarantee that a fund will outperform; simply being different from the index is not enough to beat it”.

Of course it’s not – no one ever said otherwise – but it’s nigh-on impossible to beat the index if your fund has a low active share. Investors who have paid good money to get an actively managed fund should get one, not a fund that merely hugs benchmarks.

Fund transparency – why bother?

Ironically, the asset managers named and shamed in Better Finance’s report could complain that their biggest mistake was their transparency.

The report found one in six funds could be classified as potential closet trackers, but the real figures might be much higher. Looking at 2,332 equity funds, it found 6 per cent didn’t report any benchmark in their prospectuses; another 50 per cent reported a benchmark but didn’t provide relevant information such as active share or tracking error. Overall, 57 per cent of firms “escape scrutiny because of a lack of available information”.

Irish-domiciled funds largely follow the European pattern; 12 per cent didn’t report a benchmark, another 36 per cent provided insufficient information.

It’s bizarre, really, that the industry can get away with this. Last week’s report replicated 2016’s European Securities and Markets Authority (Esma) study into closet trackers, the key difference being that Esma did not publish the names of the guilty parties.

A year on, neither Esma nor national regulators have seen fit to publicly identify any falsely active fund, notes Better Finance, while most fund firms aren’t even bothering to disclose key investor metrics.

The funds named and shamed in this latest report deserve criticism, but they’re not the only ones. Regulators’ nonchalance means the least-transparent funds are getting away scot-free.

An earnings upturn in Europe

European corporate earnings may finally be on the mend.

A total of 220 European companies have reported earnings in the current quarter, with the median firm comfortably beating earnings and sales estimates. That in itself is not necessarily cause for cheer – after all, companies are infamous for deliberately lowballing estimates so that they can "beat" estimates. However, this season's beat "appears to be of better quality", according to Barclays.

Historically, estimates are indeed managed lower prior to earnings day, but companies are currently beating estimates that had actually been adjusted higher pre-results. Furthermore, this earnings beat is being “complemented with a significant beat on sales”, something that is “harder to engineer”.

With the best results coming from cyclical stocks and defensives coming up short, the European reflation trade appears to have legs.

Era of high correlations may be over

Between 2009 and 2016, equities have tended to rise and fall in unison, but this era of high correlations may finally be over.

The dominant role played by central banks' monetary policies largely dictated this pattern, with S&P 500 sector correlations rarely falling below 80 per cent over the last seven years. However, there has been a "profound" drop in correlations since November's presidential election, according to Convergex analyst Nicholas Colas, from 75-80 per cent to below 60 per cent.

The same pattern is evident in non-US markets, with correlations returning to historical norms. “Tied to the hip” since the global financial crisis, the correlation between developed and emerging markets to the S&P 500 have fallen to 61 per cent and 35 per cent respectively.

The fact that correlations have continued to drop for months now testifies to the “lasting nature of the change”, says Colas. “This is not a blip.”

Unseemly cheers greet Killian’s Aryzta departure  

You’ve spent 40 years with the same company and announce you’re going to quit. Everyone cheers.

That was embattled Aryzta chief executive Owen Killian’s experience last week, when shares soared as much as 21 per cent after he bowed to investor pressure following a series of profit warnings.

Still, it could have been worse. How would you feel if your loved one died suddenly and investors everywhere cheered to the rafters? It happens, according to a study last year that measured market reactions to unexpected CEO deaths. The researchers found 240 such cases over the 1950-2009 period. Almost half of the time, the stock price rises. This rather brutal enthusiasm has become more pronounced over time: since 1990, gains have averaged almost 9 per cent.

An unsentimental bunch, investors.