The Central Bank of Ireland has published the outcome of a review of UCITS funds on the subject of closet indexing - the largest data-driven thematic review of the funds industry to date. It found many key investor information documents to be misleading.

The regulator looked in depth at all of the 2,550 Irish-authorised UCITS (Undertakings for the Collective Investment of Transferable Securities) funds that were, in its eyes, managed actively at a point in time in March 2018.

Closet indexing, according to the European Securities and Markets Authority, is a practice whereby fund managers claim, according to their fund rules and investor information documents, to manage their funds in an active manner while the funds are, in fact, staying very close to a benchmark and therefore implementing an investment strategy which requires less effort from the investment manager and charge management fees in line with those of funds that ESMA considers to be managed actively.

The review found that:

• funds did not always give investors enough (or even accurate) information about their investment strategies in their prospecti and KIIDs (key investor information documents), rendering them less able to make informed choices about whether or how much to invest in thsoe funds;
• there were instances of poor governance and controls by boards;
• sometimes, the fund in question had a target outperformance against an index that was less than the fee it was charging to certain share classes in the fund, so that even if the UCITS provided a return at the upper end of its projections, investors in these share classes were not realising positive returns against the benchmark, as the fees that the fund was charging cancelled out any outperformance that it had achieved.
• sometimes no comparator was included in the 'past performance' section of the KIID, stopping investors in these funds from determining whether the fund, irrespective of performance, represented good value relative to its benchmark.

Derville Rowland, the central bank's director general, said: “As well as following up with the funds where we had findings, we are requiring all UCITS funds to consider the accuracy of their Prospectus and KIID on an ongoing basis in light of these findings. Where such funds need to amend their prospectus or KIID on foot of this exercise, we are giving them until 31 March 2020 to do so.”

When looking at the annual performance of a UCITS, its board should make a note of whether it has achieved the stated objective and whether the UCITS remains a viable and suitable investment for investors.

The Central Bank found cases where multi-manager UCITS consistently performed in ways similar to indices. This begged the question of whether the UCITS were reaping the 'diversification benefits' of the multi-manager approach (as opposed to passive investing) over time. Whenever UCITS are taking a multi-manager approach, the regulator wants the board in question to consider whether this results in a strong correlation with an index to an extent that active management fees are not appropriate.