The Closet Monster

Posted by: Swindells FP, on January 5, 2014.

What is potentially worse than putting your money into a high charging actively managed fund (where the managers make investment forecasts and timing decisions with the goal of outperforming a benchmark)?  Putting your money into an actively managed fund that charges high fees and that to a large extent holds the same shares as the benchmark index its active management style is trying to beat.

Such funds are known as closet index funds, and a recent industry report claims that there are lots of these pseudo actively managed funds available to retail investors in the UK, i.e. you and I.

This could be bad news if you are invested into these mock trackers as firstly, if your fund largely mirrors an index, you’ve got even less chance of beating it.  Which is what the active fund management industry bill itself as being able to do.

There is copious evidence that the majority of active funds will fail to beat the market over the long-term; but closet index funds are even less likely to outperform.

Additionally you are paying a lot of money for less active management.  If the closet index fund charges you a 2% management fee, but only half of the fund is actually following an active management style (because the other half if just invested into the benchmark index), that means the actively managed portion of the fund is being paid the lion share of the fees.  It follows therefore that there needs to be some serious outperformance of the active portion of the fund to get over this magnified fee hurdle.

In our view the majority of the time investors are better off adopting a passive, index investing strategy into tracker funds that is simpler, cheaper, and more likely to deliver better returns over the long-term.

If you would like Swindells Financial Planning to review any of your existing investments to see if you are holding a closet tracker then please do not hesitate to contact us.


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