In the last number of years there has been a regulatory focus on active investment management and performance. A number of key regulators including ESMA, the CBI and the FCA have reviewed the market for potential hidden “closet tracker” funds and published their findings, with a number of funds providing inaccurate information in their investor disclosure documents as regards investment strategy.
WHAT ARE CLOSET TRACKERS?
Closet trackers, also known as closet indexing or index hugging, refers to the practice of fund managers claiming to manage portfolios actively when in reality the fund stays close to a benchmark.
IMPACT OF CLOSET TRACKERS
The issues around ‘closet trackers’ form part of a broader issue on the effectiveness of investor disclosure and the legitimate expectations of investors in respect of the service provided by some asset managers.
Closet trackers may result in:
- Investors making investment decisions based on an expectation that they will be provided with a more active fund management service than they receive in practice and, therefore, may be paying higher management fees than that usually envisaged for a passive/not significantly active management service;
- Investors being exposed to a different risk/return profile than they expect; and
- Asset managers not providing clear descriptions of how funds are managed in key disclosure documents such as the fund’s Prospectus and Key Investor Information Document (KIID).
Closet Trackers are now the focus of regulatory scrutiny and a clamp-down across Europe with many regulators conducting reviews into the practice.
Click here to find out more about the developments across Europe and different results of their findings.
COMMON METRICS USED TO SPOT A CLOSET TRACKER
Across Europe, regulators and ESMA have shown themselves adept at using data driven oversight to spot potential closet trackers, through large-scale data driven oversight using measures such as:
SUMMARY
The work by the FCA, ESMA, and other European Regulators on FCA Assessment of Value and on closet trackers over the last number of years shows the importance and value to the regulators of data, and their willingness and intention to use this to identify issues in the functioning and performance of the fund management industry.
It should also be noted that although the above metrics are useful tools as indicators of potential closet trackers, as the EFAMA has stated, these metrics should only be used as “a first step in the investigation of closet indexing”.
Closet trackers are the investment management equivalent of wolves in sheep’s clothing – with the spotlight well and truly on them, it is unlikely they are going to remain unnoticed in the future.
