One in five European equity funds are closet trackers that largely mimic their benchmark but charge active fees, research reveals.
However, investors have sent the majority of recent inflows into European equities into the most active funds, Morningstar said.
The Morningstar findings that 20% of funds in its research were closet indexers is damaging for the active management industry – though the firm said that the number of closet indexers was falling and that funds with higher ‘active share’ did usually outperform others.
Closet indexers are funds with a three-year average active share below 60%.
Morningstar, a funds ratings business, analysed the active share of 456 funds to see how portfolios diverged from their reference index. A fund with 100% active share would have no common holdings with its benchmark.
“Average active share levels dropped considerably during the financial crisis of 2008 and 2009 but have been rising at a steady pace since then,” said Matias Möttölä, of Morningstar.
Among the least active funds, Morningstar found that almost all closet indexers underperformed their benchmark.
Morningstar’s ‘Active Share in European Equity Funds’ looked at how active share has developed in three large-cap equity categories (growth, value and blend) over the ten-year period to 2015.
The average active share for European large-cap funds was 70% in the three-year period through March 2015.
However, Möttölä warned against using active share alone as a fund selection tool and said it should be combined with other methods.
“Investors who use active share as a fund selection tool should exercise caution. As active share increases, dispersion in returns and risk levels rises sharply, with both the best- and worst-performing funds found among the more active funds.”
Portfolio manager skill in selecting the right deviations from the index generates outperformance.
“Investors should compare fees carefully as funds with similar active shares can have fees that differ greatly,” Möttölä added.
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