An EU think tank called Better Finance has replicated a study by the European Securities and Markets Authority that identified "potential falsely active funds" (or 'closet indexers') but, unlike ESMA, has named names.

The think tank, which resides in the Belgian city of Brussels, is asking Euro-regulators to investigate further. It replicated the ESMA study of 2015 about closet indexing and identified up to 165 equity UCITS funds that could potentially be closet indexers.

Gina Miller, the investment campaigner who has written for Compliance Matters in the past, recently told the London Financial Times: “We have been shouting about the scandal of closet index tracking, which is plainly mis-selling, for years, so I am delighted to see Better Finance naming and shaming the worst offenders.”

Closet indexing

Investopedia describes 'closet indexing' as a portfolio strategy used by some portfolio managers to achieve returns similar to those of their benchmark index, without exactly replicating the index. A manager's performance is usually compared with that of his benchmark index, so he has an incentive to gain returns that are at least similar to the index.

It goes on to say that investors often dislike closet indexing because they could simply choose an index fund and pay lower fees. The word 'closet' is used because these practices are often not publicly announced, but a close examination of a fund's prospectus (as perhaps in this exercise) can sometimes unmask the perpetrators. Investopedia adds: "Watch for funds with high MERs [management expense ratios] and holdings that look quite similar to the fund's benchmark index." In other words, the funds charge premia for their supposed investment expertise but never wander far from their benchmarks.

Closet government

EU institutions often fight shy of naming names when describing problems, often because they do not want to look as though they are favouring certain countries over others. Europol's reports regarding financial crime in the European Union, for example, have in the past been notorious for their lack of clarity on this matter, referring to vague zones such as 'South West Europe' to gloss over the deficiencies of this-or-that country's anti-money-laundering regulators.

Better Finance is a public interest international organisation, partly supported by the European Union. It sees itself as a financial expertise centre that promotes training, research and information about investment, savings and personal finance in the EU. It seems, therefore, that the EU was sheepish about revealing the names on the list itself for fear of causing offence, so it surreptitiously instructed one of the organs on its payroll to do the job for it.

Inside the closet

The list contains the names of funds such as UBS (Lux); Threadneedle Asia; Swedbank; Skandia USA; Scottish Widows American Growth; Schroder Gobal Emerging Markets; Santander North American Equity; RaffeisenFonds SwissAc; Pictet-Greater China; Nordea Suomi; JPM Euroland Equity; Invesco ASEAN Equity; HSBC Euro Actions; HSBC GIF Chinese Equity; Halifax Far East; Fondersel Europa; Fidelity Global Health Care; Danske Invest Suomi Osake; BNP Paribas Euro Valeurs Durables; Atout Euroland; Allianz Adiverba; and Aberdeen Global Emerging Markets Quant Eq A.