The 'r squared' ratio that highlights Isa funds to avoid

A sophisticated tool for identifying investments that outperform has discovered that many of Britain's most popular funds instead fail to beat the wider market, despite charging high fees.

By dumping these funds and switching to a cheap "tracker" fund, which blindly follows the stock market, savvy investors could net a 90pc reduction in cost. They would also have a better idea of what they were getting for their money.

Funds that claim to choose their holdings carefully but in reality simply mimic an index such as the FTSE 100 are called "closet trackers".

The innovative analysis tool identified 82 funds available to British savers as closet trackers. In total £23bn is held in these funds.

Many of them are funds run by banks, building societies and big insurers. These funds are no longer heavily promoted, with banks pulling back from offering investment advice. But these funds still have a large number of investors, many of whom continue to make regular contributions as the funds are still open for new investment.

But dozens of funds run by specialist fund management firms were also identified by the fund analysis tool or "screen".

The research was carried out by Saul Djanogly, the founder of the Investment Fitness Club, an advisory firm. He said: "It's time for the fund management industry to be more honest with investors. There is nothing wrong with charging for a service if it delivers, but too many people are being sucked into expensive funds that do not add value.

"The challenge for investors is identifying these sheep in wolves' clothing - even many professional advisers don't know how to identify them."

To work out which funds are "closet trackers" Mr Djanogly used a complex mathematical measure called the "r squared" ratio. This is intended to work out how closely correlated a fund's holdings are to the stock market it is supposed to beat.

If the figure is 100pc then the fund's performance has been driven by mirroring the index, Mr Djanogly claimed.

He said any fund with a ratio of 95pc or more was essentially a tracker fund that could not justify its premium "active fund" charge.

The worst-scoring fund on his screen was the NatWest UK Equity fund, which scored 99.9pc. The analysis is indicating that only 0.1pc of the fund, which costs 1.2pc a year, is different from the relevant index, the FTSE All Share.

An investor could pay 90pc less by buying a tracker fund that promises to do just that - track the market. The Fidelity Index UK and Vanguard FTSE UK All Share Index funds cost 0.08pc a year.

An investor who uses this year's full Isa allowance of £15,000 would save thousands of pounds by switching. Assuming that both the NatWest fund and the Fidelity tracker fund returned 6pc each year over the next decade, a £15,000 investment today would grow to £23,972 and £26,686 respectively. A £2,714 saving will be made for same investment performance.

Among the other funds that were identified by the screen as having an r squared ratio of 98pc or more were Melchior Japan Advantage, First State Asian Property, F&C Pacific Growth, JPM Asia and Henderson Japan Enhanced. This implies that only 2pc of their holdings differ from the relevant index.

Other popular funds that have a score of more than 95pc include M&G Global Emerging Markets, which has £1.7bn of assets, and the £1.4bn Schroder Tokyo fund.

The funds that seem to track

Source: Investment Fitness Club and Morningstar. Data to the end of July.

The funds that are not 'closet trackers'

There are dozens of fund managers who makes active bets and a few who seem able to beat the stock market - and their peers - consistently over the long run. If you're paying a higher management fee, you should expect a portfolio that does more than mirror a market. Respected funds that deviate clearly from the market, according to the r squared analysis, include MFM Slater Recovery, managed by Mark Slater, Marlborough Multi Cap Income, Invesco Perpetual High Income and Unicorn UK Growth.

What is the 'r squared' ratio?

The ratio measures how closely the performance of a portfolio resembles the performance of a market or index. In other words, has a lot of active stock selection taken place? Or has a portfolio been built along the lines of the stocks that form an index? The score ranges from 0pc to 100pc. Those with a score of 95pc or higher are essentially just mimicking the performance of the index, experts say. These scores can be found at morningstar.co.uk.

• Get Twitter alerts for all our investing stories: follow @telegraphinvest

• Investment ideas every week by email – sign up here