When you give money to a fund manager, you expect them to use expert knowledge to grow your nest egg.
But what if you paid them big fees only to find they simply copied the FTSE 100 index?
These are known as ‘closet trackers’ and it is thought there are at least 84 of them on offer, according to the City watchdog.
They are called this because they operate in the same way as a robot-controlled tracker fund: they move up and down with the benchmark by choosing many of the same stocks.
But the big difference is these funds often don’t tell you they are doing this, yet they charge as much as ten times more than a tracker would to do the same job.
Once charges have been deducted from your pot, you will be much worse off than if you had invested in a cheap tracker.
For example, in five years the tracker fund L&G UK Index Trust returned 35.1 per cent versus 39.2 per cent for the FTSE All Share it is designed to mimic.
Lindsell Train UK Equity, a fund where the manager seeks to beat the index, has returned 79 per cent in five years.
Scottish Widows UK Growth, on the other hand, claims it aims to beat the same index but has returned just 28.5 per cent in five years. This is because it charges 1.46 per cent, against 0.56 per cent for the L&G tracker.
The Financial Conduct Authority says the problem is that many closet trackers are misleading savers with their advertising.
So far, asset managers have had to pay £34million in compensation to misled savers.
Megan Butler, the watchdog’s supervision chief, said: ‘We want customers to have confidence that, when they buy a fund, they know it will do what it says on the tin.’
Experts are urging savers to review their funds after the FCA’s findings.
And while the City watchdog has refused to reveal the funds it identified, there are ways you can tell a closet tracker from a fund genuinely trying to beat its index.
The first thing to do is to get hold of your fund’s factsheet. You can get these for free by visiting the asset manager’s website.
‘Closet trackers’ operate in the same way as a robot-controlled tracker funds
The most important information to look for are the top ten holdings, the index it measures itself against and the annual performance figures.
Compare the top ten stock picks with those of its benchmark index. If about seven or eight are the same, then it is a sign that your manager is not taking many bets over and above the index. But that alone is not enough evidence to determine whether or not you are in a closet tracker.
Adrian Lowcock, of investment firm Architas, said: ‘Some managers might not make big bets that vary from the index, so that is not a guarantee that you are in a closet tracker. Even in this case, you could be in a fund that outperforms the index because of the way the manager has allocated the money.’
However, checking the fund’s performance against its index can help weed out rip-off closet trackers. Check the annual returns against those of the index. If your fund is returning slightly below that of the index, it is a bad sign.
It is easier to plot both on a graph so you can see the fund following the index up and down.
Data firms such as FE Trustnet have free tools that let you do that. All you do is pick the index and the fund you want to chart.
Finally, check how many companies your fund is invested in. If it is 60 to 70 or more then it is usually an indicator that your fund is set up to mimic an index. This information can usually be found on the fund factsheet as well.
A Scottish Widows spokesman said: ‘The fund is actively managed and holds a broad range of stocks, which target a consistent, modest level of outperformance, rather than a highly focused portfolio that may perform in a more volatile manner. It is designed to outperform the FTSE All Share index with a low tracking error.’