Since publishing a previous article on closet index trackers back in December 2014, the topic has received a lot more coverage in the financial press. Closet index trackers are those investment funds that claim to be “actively” managed and charge fees more commonly appropriate to that investment management process, while in reality their funds are so similar to those of index tracking funds that they match the index. The allegation is that they are obtaining higher fees on the pretence of doing more work such as investment research (as active styles require) while in reality they are just following the herd.
Funds that are alleged to be closet trackers by SCM Private are Halifax UK Growth C, Scottish Widows UK Growth A and Santander PF UK Equity A and it may be no co-incidence that these are all bank controlled funds (the first two by Lloyds).
The Danish regulator launched an investigation into the matter last September and now the Swedish authorities have apparently launched an investigation as part of a review of asset management. It follows alleged legal action by the Swedish Shareholder Association accusing one fund manager of “mis-selling” closet index trackers to retail investors. Note that proving any “losses” from such mis-selling might be somewhat difficult assuming that they did hug the index because some people claim that index funds generally beat actively managed funds – but that is after taking into account costs of course. The fact that someone promoted the likely merits of their fund by claiming that an active management style would generate higher returns might be one basis for a claim but only if in fact it was not undertaking the processes claimed. Otherwise they might simply claim it was co-incidence that their stock choices or performance matched the index.
ESMA, and Better Finance who represent European private investors, have also been looking at this issue and now the Financial Conduct Authority (FCA) have indicated that they might look into the matter later this year.
Is it important to private investors? Well it does if you invest in funds without thinking, without looking at what they are invested in, or simply taking advice from someone else (and particularly banks). Chris Dillow highlighted that in the Investors Chronicle edition last week (dated 20/2/2015) where he reported that “financial advice was worse than useless” based on a report from the University of St. Gallen. Those retail investors who took their own advice performed better than those who received bank adviser input.
Would it help to have a measure of index tracking closeness in fund disclosures (e.g. in Key Information Documents (KIDs)? The key problem might be how to define such a measure in a useful and consistent manner. There would also need to be some evidence that investors could actually make good use of a report on the level of index hugging. As investors we are already deluged with so much information that adding more might simply confuse people, particularly if the consumers did not understand what it meant.
Of course if you invest directly rather than via a fund then you don’t have this problem at all because your portfolio can look totally different to an index . That of course might be a danger in itself if you pick the wrong stocks or sectors. But you will certainly be sure to avoid index tracking.
In the meantime there is surely a suspicion that all the hot air on this subject is being generated by those active managers keen to prove they have something special to offer in face of the recent onslaught of low cost index trackers.
Losses incurred by being mis-sold a closet index tracker (CIT) are quantifiable: they would be the difference in TSR between investing in the CIT and investing in a low-cost ETF that tracks the index the CIT is following. That difference would represent the impact of the overblown charges.
Yes but as the difference would only arise from charges, which had been made plain to them when they signed up no doubt, it might be difficult to make a claim for losses in English contract law (not sure about the law in Sweden or other countries though). Might require the FCA to conclude that “mis-selling” took place in the UK and that might result in a penalty on the provider but not necessarily compensation for the investor.
I have been told:
Harcus Parker has been investigating claims against fund managers and others for closet tracking: the practice of describing a fund as actively managed and charging for that service but in fact merely tracking an index or constraining performance, with the effect of tracking an index.
The FCA has been investigating closet tracking for several years, and fined Henderson Investment Funds Limited £1.9m in 2019 for failing to treat fairly 4,500 retail investors in two funds which charged active fees. There has also been activity abroad, with litigation having successfully been pursued in Norway and two ongoing class actions in Canada.
We are currently focussing our investigations on Scottish Widows and in particular the Scottish Widows UK Growth Fund. If you have invested in this fund, we would really like to hear from you in order for us to further our investigations. This fund has been the subject of several articles discussing closet tracking in the UK and recently featured as a ‘Dog Fund’ (an underperforming investment fund) in Bestinvest’s Spot the Dog Fund Report for 2021. Bestinvest provide the following statement about Scottish Widows generally:
“For Lloyds Bank owned Scottish Widows, it is not necessarily the size of assets in dog funds – £2.73 billion – but the range. It has four dogs, across a surprising variety of sectors – Scottish Widows Pacific Growth, Scottish Widows American Growth, Scottish Widows UK Growth and Scottish Widows UK Equity Income. Again, it is disappointing to see large UK funds underperforming after a better period for UK markets. Take note that the investment adviser on these funds is Schroders.”
Please contact them by email at email@example.com or by telephone on 020 3995 3878 if you are an investor in the Scottish Widows UK Growth Fund and would be interested in hearing more about how you can help us.