CNBC Comment: Why active funds struggle to outperform

IT’S ONLY 91 days until Christmas and, for the movers and shakers in the fund management industry, we’re close to “squeaky bum time”. This is when we begin to see who has delivered the goods, and who has to start lining up their excuses for another year of underperformance.

Yet unlike in the Premiership title race, which Sir Alex Ferguson’s famous quote referred to, fund manager performance should have quite an even distribution of winners and losers, rather than just one overall winner. You would think it fair to presume that, among the active managers running equity market money, a decent percentage should be beating the index they are tracking. Well apparently not.

In fact, as I pointed out in this column earlier in the year, active managers are for the most part being trounced by passive index-tracking products. Now, according to a new report this week, it appears that this underperformance by active managers may in part be down to a “scandalous index cloning epidemic”.

SCM Private’s analysis has taken a sample of 127 retail UK funds that are managing a combined £120bn, and then looked at their performance compared with 227 US mutuals managing a combined £453bn. SCM found that, far from selling funds that were able to “beat the market (or index)”, the funds were in many cases “highly unlikely to achieve the objectives marketed to investors”.

Why? It appears that, of the funds looked at, “an average 40 per cent of each fund is identical to the same index the fund is aiming to beat”, and were charging some pretty high fees to clients for the privilege.

The research adds that, if investors had used a low cost index fund instead of these underperforming active funds, which were found to be “disguised index clones”, they could have saved an estimated £1.86bn in UK equity fund fees and over a billion in overseas fund fees in the past five years.

To underline the cloning accusation, the SCM report points out that only a quarter of the UK funds analysed were radically different to the index, compared with 65 per cent of US funds.

Among other things, the report calls for far more transparency from the UK fund industry in reporting 100 per cent of holdings more regularly (it’s been a requirement in the US to do so quarterly since 2004), and that the marketing of funds should be more honest about how much of its investment is merely tracking the index.

So as we close in on the final quarter of the trading year, I await with interest to see who has managed to actually beat the Footsie over the twelve month period and who has matched it point for point, minus, of course the fat annual management charge.

Steve Sedgwick is anchor for CNBC’s Squawkbox Europe.