Irish Regulator to Crack Down on Closet Trackers

The Central Bank of Ireland is the latest European regulator to investigate funds that charge fees for active management but closely follow the performance of their benchmark 

Holly Black 18 July, 2019 | 2:02PM

markets

The Irish regulator has announced a review of “closet tracker” funds, which charge fees for active fund management while doing little more than copying the index.

The Central Bank of Ireland said it wanted to identify funds describing themselves as being actively managed, whose performance is close to the index.

The regulator analysed 2,550 Irish-authorised funds against a number of technical measures to identify those which appeared to move closely in line with an index. From this, it identified 182 products which required further review. Of these, it has engaged with 62, and will follow up with the remaining funds over the coming months.

The Irish regulator is the latest to crack down on closet tracker funds. The European Securities and Markets Authority (Esma) has also been investigating closet trackers in recent months. The regulator has previously warned that up to 15% of European funds could potentially be charging fees for active management while closely tracking their index and asked national regulators across the EU to investigate further.

In July 2017, the Financial Conduct Authority warned that up to £109 billion of investors' money could be sitting in closet trackers. The FCA unveiled new rules earlier this year that would help investors identify funds which charge higher fees but appear to closely track an index.

Under the new rules, which came into effect in May for new funds and take effect in August for existing products, firms will have to explain why a given benchmark has been chosen for a fund and to show how the fund has performed compared with that benchmark.

Check the Tracking Error

In its review, the Central Bank of Ireland said investors are not always given “sufficient or accurate” information about a fund to enable them to make an informed decision on whether or not to select it. In some instances, a fund's board did not regularly assess whether the performance was what investors should expect from an actively managed fund and what they were paying for it.

Investors concerned that they may be paying too much for a fund that is a closet tracker should start by checking the performance tracking error of the fund against its benchmark. The FCA says a fund with a tracking error of 1.5% or less compared with their benchmark could be a closet tracker.

You can also check the “active share” figure, which is available on many fund fact sheets. This figure indicates the percentage of the portfolio that differs from the benchmark. Experts typically suggest anything below 80% could be cause for concern.

However, Jonathan Miller, head of UK manager research at Morningstar, has previously warned that investors should be cautious in focusing in on one measure to determine how active or not a fund is. Research has shown that a high active share doesn't always lead to outperformance.

Morningstar analysis in 2018 found that of 127 funds in the UK All Companies sector, some 31% had an active share of 60% of lower but half of these had outperformed a UK equity tracker fund over three years. Miller added: “It is right that attention should be drawn to this, however, a number of measure should be brought together to draw conclusions: transparency, value for money, and clear communication to investors are key.”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Holly Black  is Senior Editor, Morningstar.co.uk

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