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Why you should avoid closet trackers

by , 18 November 2013

If you decide to use a unit trust fund to invest in the stock market, you have two main options. Firstly, you can buy an actively managed unit trust fund. It will cost you more, but in return the manager will try to beat the market. Or secondly, you can buy a ‘passive' fund, which just aims to track the underlying index. It won't give you anything more than the return on the market, but it's a lot cheaper because the fund manager has no stock-picking decisions to make. But what if your active unit trust fund is a closet tracker? Read on to find out why you should avoid closet trackers…

Passive unit trust funds are a good option to go with, Phil Oakley in MoneyWeek explains…

That’s primarily because history tells us that most active managers fail consistently to beat the market – partly because their fees are so high. Why give them all that money if they can’t do the job?

That said, trackers aren’t perfect.

But there’s one type of unit trust fund you should never have in your portfolio – the ‘closet tracker’ fund.

Don’t pay high fees for tracker fund performance

This gives you the worst of both worlds – you pay the high fees of active management, but what you actually get is, in effect, an index-tracking fund.

A recent study by British wealth manager SCM Private suggests there are a lot of these funds out there. Under SCM’s measure, a fund is a closet tracker if 60% or fewer of its holdings (its ‘active share’) differ from the underlying index.

A pure tracker fund would have an active share of zero.

Closet tracking is one of the biggest rip-offs in the fund management industry.

If you do hold a closet tracker, sell and buy a cheaper passive unit trust fund.

If you really want to pay for active management, watch out for high fees and ensure that you understand the manager’s strategy, and that it involves doing something more complicated than just hugging the benchmark.

So there you have it, why you should avoid closet trackers.

Why you should avoid closet trackers
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