In 2012, we identified 24 funds as potential closet trackers across the IMA UK All Companies and IMA Global Emerging Markets sectors. This year, just nine were highlighted: two in the IMA Europe ex UK sector, four in the IMA North America sector and three in the IMA UK All Companies sector.

The metric is based on funds with a three-year annualised tracking error of less than 4.55 per cent and an R-squared value of 95 per cent or more.

Starting with the IMA UK All Companies sector, the most tracker-like fund in this year’s list is the AXA General fund, which carries an R-squared figure of 98 per cent, a three-year annualised tracking error of 2.28 per cent and an active share of just 24 per cent. In spite of carrying a total expense ratio of 1.04 per cent, the fund has underperformed the IMA UK All Companies sector three-year average return of 44.93 by 4.49 percentage points.

“The fund aims to achieve capital growth with an increasing income,” the group says. “The portfolio consists principally of UK equities and may include investments in either or both of North America and Japan [and] other classes of UK investment.”

The JPM UK Managed Equity fund was close behind, with an R-squared figure of 97 per cent, a three-year annualised tracking error of 2.41 per cent and a 31 per cent active share.

Mike Parsons, head of UK funds sales at JP Morgan Asset Management, explains: “JPM UK Managed Equity has always been run as a low-risk, low-tracking error fund. It has outperformed its benchmark, before fees, over six months and one, two, three, four and five years, in spite of having a lower ex-post [historical] tracking error than the average passive fund. This shows it is possible to generate alpha in the low tracking error space.”

Mr Parsons said the fund has experienced difficult performance following the collapse of Lehman Brothers. The analysis for this report shows a three-year cumulative return of 38.54 per cent to the end of May 2013, compared with a 44.93 per cent return from the sector and a 41.17 per cent return from its FTSE 100 benchmark index. However, the fund is now ahead of its benchmark, net of A Class fees, for six months and one and two years.

The Franklin UK Select Growth fund, which recently saw the addition of co-manager Ben Russon, only just made it onto the list. With an R-squared figure of 95 per cent, a tracking error of 3.42 per cent and a 53 per cent active share, this fund sits very close to the cut-off point.

However, it also featured on last year’s list, when it was under the sole management of Mark Hall. Mr Russon’s appointment in April has resulted in the fund altering its style, most notably by reducing the number of holdings from 65 to 50 and holding a greater concentration of FTSE 100 stocks.

Among those funds highlighted as potential closet trackers in the IMA North America sector, the JPM US Select fund fares worst, with an R-squared value of 98 per cent and a three-year annualised tracking error of 2.24 per cent. The fund carries an active share figure of 56 per cent.

Mr Parsons says the fund is run with a lower level of active share, which is used to “manage the attendant macro and micro risks as carefully as possible”. He says the fund’s goal is to “deliver strong relative performance and a high degree of consistency”. This is evident when the fund is compared with the wider sector and the S&P 500 benchmark index – it has delivered top quartile returns in six months and one, five and 10 years.

“A portfolio running a moderate active share and high information ratio may perform better than a portfolio taking big bets,” Mr Parsons says.

Two Legg Mason funds have made it onto this year’s list – the ClearBridge US Appreciation and the ClearBridge US Large Cap Growth funds.

The former carries an R-squared figure of 97 per cent, a tracking error of 2.28 per cent and a 50 per cent active share. Adam Gent, head of UK sales at Legg Mason, says: “The Appreciation strategy was initially launched in the US in 1970 with a clear mandate to deliver competitive returns over a market cycle – three to five years – with 15-20 per cent less volatility than the S&P 500.

“The strategy has delivered these characteristics on a number of occasions, notably during the 2007-09 period. In 2008 the S&P 500 lost 37 per cent, while the fund was able to limit its capital loss to a 30.1 per cent decline. The following year saw a sharp market rebound starting in March. In 2009, while the S&P 500 rose 26.46 per cent, the fund was up by 19.2 per cent, thereby capturing more than 72 per cent of the upside... These are not the attributes of a closet index tracker.”

The IMA Europe ex UK sector contains just two potential closet trackers, according to Investment Adviser’s research – Axa Rosenberg European and HSBC GIF Euroland Equity. Both sit on the cut-off point, with an active share of 60 per cent.

A spokesperson from AXA Investment Management says the fund’s objective is to outperform its FTSE Europe ex UK benchmark by 2 per cent in the long term. “Given the nature of our investment process and [our] target of delivering ‘benchmark-plus’ performance, we are not surprised to see a close correlation of return on a month-on-month basis with the benchmark, given the metrics chosen,” the spokesperson adds.

Frederic Leguay, head of European equities at HSBC, agrees that statistical measurements of relative risk only provide a partial picture.

“In the past 12 months, the fund has outperformed its relative benchmark by more than 10 per cent net of fees at end May and 11.5 per cent gross of fees. This type of outperformance is inconsistent with that of a tracker.”

When it comes to the end client, advisers need to ask themselves whether funds that have demonstrated tracker-like tendencies have a place in a portfolio, or whether a better product is available.

Jenny Lowe is features editor at Investment Adviser