European Regulators Watching Closet Indexers

From Institutional Investor:

Authorities in Europe have turned their attention to funds that track the index while charging active management fees.

Since the 2008–’09 financial crisis, U.K. asset manager SCM Direct has been calling for a name-and-shame campaign against closet index funds. Such funds purport to be actively managed, but they hug their benchmarks so closely that returns often track the market, leaving investors with a high-priced index product. As investors and regulators demand more transparency, managers with a limited active share in their funds may see enforcement actions.

“In today’s investment landscape it is increasingly difficult to beat the market on a repeatable basis,” says SCM founding partner Gina Miller. “Active management is a dream, and these funds have been selling snake oil for far too long.”

The financial crisis prompted SCM to investigate the underlying holdings of several retail funds to which it had exposure. But the task was daunting, Miller recalls: U.K. regulations require mutual funds only to reveal their top-ten holdings.

In Sweden, national shareholders’ association Sveriges Aktiesparares Riksförbund sued Swedbank Robur, the country’s largest bank, after it admitted to hugging the index so closely with some products that their chances of success were extremely low. That landmark class action suit, which included 3,000 investors, was dismissed last July. Still, Swedish regulator Finansinspektionen (FI) released a consumer protection report that includes a plan for tightening regulation of closet indexers. FI found evidence of funds being marketed as active but exhibiting the kind of ultralow tracking errors common among index products....MORE