'Closet index' funds charge high fees but lag indexes

Mon Feb 3, 2014 10:32am EST
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By Tim McLaughlin

BOSTON Feb 3 (Reuters) - Investors are paying hefty fees for mutual funds that bill themselves as actively managed but in large part are mimicking a benchmark stock index.

Such funds have less chance of beating the market. And they charge fees comparable with those of funds that offer investors more stock pickings that are different from their benchmarks.

Since the height of the U.S. financial crisis, more funds are playing it safe, hugging their benchmarks and sometimes earning the unwanted reputation as "closet indexers."

About one-third of U.S. mutual fund assets, amounting to several trillion dollars, are with closet indexers, according to research published last year by Antti Petajisto, a former Yale University professor who now works for BlackRock Inc.

In general, Petajisto defines a closet indexer as a fund with less than 60 percent of its investments differing from its benchmark.

"The performance of closet indexers has been predictably poor: They largely just match their benchmark index returns before fees, so after fees, they lag behind their benchmarks by approximately the amount of their fees," Petajisto said in his study published last year in the Financial Analysts Journal.

For example, the $5.3 billion ClearBridge Appreciation Fund largely follows the Standard & Poor's 500 stock index and charges a minimum fee of 0.61 percent, compared with 0.10 percent or lower for an unmanaged index fund.

But ClearBridge Appreciation, which is run by Legg Mason Inc , has lagged the S&P 500 by 2.62 percentage points over the past five years, according to research firm Morningstar Inc .   Continued...