The magic number that could save you a FORTUNE

Keeping the cost of investing down is always important, whereas in turbulent times, when most portfolios are falling, it is absolutely integral to preserving your wealth. 

One way to work out whether you’re getting good value for money is seeking out a little-known number, known as the active share. 

Investment experts use it as an indicator of how hard their fund managers are working for them. Then, if they find their fund managers are not justifying their fees, they can ditch them for a cheaper option. It’s a tool that ordinary investors can use too. 

Indicator: One way to work out whether you’re getting good value for money is seeking out a little-known number, known as the active share

Watch out for closet trackers 

There are two main approaches you can take when investing. You can either buy an active fund, which is a selection of investments hand-picked by an expert fund manager. Or you can go for a passive fund, which buys all of the investments in a particular index. For example, a passive fund that tracks the FTSE 100 simply buys all of the 100 UK-listed companies in that index. 

Active funds tend to cost more because you are paying for someone to pick your investments. The hope is that their expert knowledge allows them to spot the best investments and produce a higher return than the index they are benchmarked against. 

But this is where investors need to watch out. Sometimes, active fund managers simply put together a portfolio that looks almost identical to the index they are trying to outperform. 

These funds are so-called closet trackers – because they dress themselves up as active funds but in reality do no more than hug their benchmark. 

‘Given the additional fees that actively managed funds charge, there is little value investing in one that consistently looks like the benchmark it’s trying to beat,’ says Ryan Hughes, head of investment partnerships at investment platform AJ Bell. 

New analysis from investment platform Interactive Investor has found that ten per cent of all investment funds are ‘closet trackers’. 

The power of the active share 

The active share is a measure of how different a fund’s portfolio looks in comparison to its benchmark. It is expressed as a percentage. So if, for example, a fund has an active share of 40 per cent, 60 per cent of its holdings will be the same as a passive fund that follows the same benchmark. 

Jason Hollands, managing director of wealth manager Evelyn Partners, says: ‘The active share is effectively the extent to which a portfolio differs from its benchmark index. 

‘A high active share is therefore an indication that the fund is taking bolder positions than the index in the hope of delivering investors outperformance.’

How to pick the right number 

As a rule of thumb, if you are paying for active fund management, you should expect a high active share. Hughes says that funds with an active share of over 80 per cent should be seen as ‘sufficiently different to the benchmark’. 

He adds: ‘Below that, investors would probably be better off investing in a cheap tracker fund.’ Rob Morgan, investment analyst at broker Charles Stanley, believes that upwards of 70 per cent active share is ‘a good sign’. 

‘There is no right or wrong number,’ says Morgan. ‘But we like to see a high figure to demonstrate differentiation of an active investment approach.’ 

James Yardley, research analyst of investment group Chelsea Financial Services, says investors should consider the active share over time. 

‘There may be times when good fund managers pull back and drop their active share down to 60 per cent because of market conditions, but then they may increase their active share up to 80 per cent in the future,’ he explains.

Ask your broker for the figure 

Some fund managers, such as Edinburgh-based Baillie Gifford, disclose their active share on their monthly factsheets, but others do not. 

‘If I were cynical – which I am – it comes as no surprise that the fund firms that do publish this ratio tend to have a high active share,’ says Kyle Caldwell, collectives editor at investment platform Interactive Investor.

‘Fund firms are not required to publish this ratio, so it is not widely available. But it should be.’ 

Yardley, at Chelsea, suggests asking your fund broker if the active share is not apparent on your fund’s factsheet. There are also some quick checks that you can do that should give you some idea whether a fund has a low or a high active share:

• Check the fund performance: If a fund is closely tracking the performance of its benchmark, it could be a closet tracker. If it has good and bad years when compared to the index, it probably has a high active share. 
• Check the number of holdings: A concentrated fund of between 20 and 40 holdings is likely to have a high active share. Yardley says that a fund with 150 plus holdings is often a red flag for a closet tracker. 
• Look at the top ten holdings: If the list of top ten shares held in the fund is simply a list of familiar stocks, the active share is likely to be low. 

Save fees with cheaper trackers 

If you find out that some of the funds you hold have a low active share, replacing them with cheaper tracker funds could save serious cash while yielding similar investment results. 

Hughes says investors can expect to pay around 0.85 per cent per year for most closet trackers. Replacing them with cheap passive funds charging just 0.07 per cent per annum, such as the iShares FTSE 100 tracker, would save around £150 in charges every year, Hughes says. This is based on an investment of £20,000. 

Hughes adds: ‘These savings are significant and over the long term will make a huge difference to investors’ wealth.’ 

Experts’ choice of low-cost funds 

There are several cheap tracker funds you could use to replace your closet trackers. As well as the iShares FTSE100 tracker, Hughes suggests the Fidelity Index World fund, which has ongoing charges of 0.12 per cent per year and gives exposure to the world’s largest companies. Last year it fell 2.9 per cent, but it is up 34 per cent over three years. 

A word of warning 

It is worth remembering that although the active share is a useful measure, it should not be used to assess the worth of a fund on its own. Nor should you assume that a high active share automatically equals investment outperformance. 

‘It’s one ingredient in the mix,’ says analyst Morgan at Charles Stanley. ‘Active share doesn’t make something good or bad. It’s just something to take into account in your assessment of an investment fund.’ 

‘A high active share doesn’t mean an investment fund will outperform,’ Ryan Hughes agrees. ‘All it tells you is that the performance is likely to be different to that of the index it’s trying to beat. It could be better, but may also be worse.’ 

This post first appeared on Dailymail.co.uk