Esma research confirms ‘closet trackers’ offer bad value

Investors in “closet index” funds are effectively being overcharged for the funds’ performance, research from the European markets regulator suggests.

The European Securities and Markets Authority said that while potential closet trackers were associated with slightly lower total costs than their truly active counterparts, these costs were “far above those for passive funds”.

“Closet indexers therefore appear to pass on to consumers only a small share of the lower economic costs of benchmark-tracking compared to active managed [funds], rather than engaging in price competition,” the researchers from Esma said in the report.

It also found that funds engaged in potential closet indexing were associated with slightly reduced performance on average compared to genuinely active funds.

The team focused on EU asset managers that claimed to manage their funds in an active manner, but were actually tracking or staying very close to their benchmark index.

The researchers looked at more than 3,000 Ucits equity funds, domiciled in the EU, that were not categorised as index-trackers and that had management fees of more than 0.65 per cent of the total net asset value (NAV) of the fund.

They examined both portfolio composition and performance and compared them to the funds’ benchmarks. They claim their work is the first to examine closet indexing and investor outcomes for EU-domiciled equity funds for all active mandates, and the first to investigate return-based measures of closet indexing for this market.

The practice of closet indexing is coming under increased regulatory scrutiny because it is seen as misleading to investors who might be exposed to a different risks and returns to the ones they believed they were getting, while also being subject to higher fees than they would have paid for a passive fund that explicitly tracked the same index.

The UK’s Financial Conduct Authority’s latest guidance updated at the end of last year said fund managers “are expected to communicate fund investment objectives and policies in a fair, clear and not misleading way”.

It added that “where we discover firms are failing to meet our expectations, we will take appropriate action”.

The FCA fined Janus Henderson almost £1.9m in November last year after it found that the asset manager had failed to inform its investors that it was reducing the amount of active management of its Japanese and North American funds.



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