Square Mile Investment Consulting and Research (Square Mile) today confirms it has extended its Academy of Funds to include "R" ratings for open-ended passive funds, with a total of 46 funds achieving this recommendation initially. These recommendations are designed to help investors select the most appropriate passive funds to meet their objective of matching index returns most closely.

Square Mile's assessment identifies funds that follow a low-cost approach to approximate the average market return, and can be held for the longer-term. Funds achieving "R" ratings are typically run by investment companies that demonstrate a firm commitment to running passive strategies. They track an index suitable to retail investors such as regional equity and gilt markets and are low cost, managed efficiently and of sufficient size to allow an accurate implementation of their strategy.

There are several steps underlying Square Mile's assessment of funds:

• A screen of the universe for realistically priced products with 30bps as a typical cut-off point - ratings are based on current fees and charges rather than referencing historic data
• A screen to reject funds below £50m in assets under management
• The historic gross daily performance is collated and adjusted to reflect the current fee schedule
• A calculation of the 30-day moving average for 12 month rolling data
•The formulation of the rating is based on quantitative data which is qualitatively assessed.

As total return is the principal rationale for investment, return difference, defined by the difference between the performance of the fund and the index it tracks, is a key consideration. Square Mile believes that it is of lesser value to assess how closely a fund mirrors every market movement and tracking error will only be used as a sanity check within the rating process. Square Mile will consider the various techniques employed to replicate index performance but this will be of secondary importance to the success a fund has had in delivering a stated outcome.

Recommended passive vehicles will be listed in Square Mile's Academy of Funds and will be complemented by factsheets which will offer guidance on the key differences in the diverse range of indices tracked, including:

• A note of the index tracked.
• The investor outcome the product will meet
• Fund structure and domicile
• Fund pricing and dealing time
• A fund's fair pricing policy;
• Stock lending policy

Jason Broomer, Square Mile's Head of Investment, said, "There has been a significant increase in interest in passive strategies with some £50bn of the £165bn invested in mainstream UK equity funds now held in passives. Cost has been a key driver of this interest. However, since the implementation of RDR, 85% of active UK equity funds have AMCs below 1% while £10bn sits in UK retail index trackers whose AMC exceeds 1%. We feel the focus should be on the much more important consideration of whether a fund - active or passive - meets investors' desired outcomes. The new recommendations on passive funds within our Academy of Funds will help investors determine whether a strategy is suitable for their objectives.

Charges have a significant impact on a passive fund's ability to perform and while the perception is that passive vehicles are a cost efficient means of gaining market exposure there is gross discrepancy in the fees levied on funds. £1 in every £5 invested in UK passive vehicles sits in vehicles with an AMC in excess of 1%. By comparison, the cheapest funds have charges of one tenth of this and investors in UK passive funds could save £110m per year by switching from high to low cost providers. This equates to £90 per year for individuals with £10,000 invested in index trackers."