“Although we identified one in five European equity funds as a closet indexers, our research shows that the proportion of closet indexers has been shrinking,” Möttölä said. “Average active share levels dropped considerably during the financial crisis of 2008 and 2009 but have been rising at a steady pace since then. In Europe we’ve witnessed increasing scrutiny from regulators in many countries, which could lead to structural change and less closet indexing in the market.”
It is important to make the point that the issue around active share is not centred only on performance, it is also about value for money. While funds with very low active share do tend to underperform after costs relative to the index, the picture is very mixed as to how closely related high active share levels and outperformance are.
“Investors who use active share as a fund selection tool should exercise caution,” said Möttölä. “As active share increases, dispersion in returns and risk levels rises sharply, with both the best and worst performing funds found among the more active funds. It is the portfolio managers’ skill in selecting the right deviations from the index that generates outperformance.”
“Among the least active funds, we found that almost all closet indexers underperformed their benchmark,” he continued. “If combined with high fees, such a fund is rarely a good choice. Investors should compare fees carefully as funds with similar active shares can have fees that differ greatly. We believe active share is best used only in combination with other quantitative and qualitative tools.”
It is increasingly clear that if a manager is putting together a fund that looks very much like the index, charging fees of up to ten times higher than a tracker is not sustainable.
