'Closet indexing' crimping active returns

By Tim Stewart
 — 1 minute read

While plenty of active mangers are still outperforming their benchmarks, some are offering investors index returns for active management-level fees, says Ranger International.

In a note to investors, Ranger International pointed out that not all active fund managers are truly active – and some "stick closer to a benchmark, than paparazzi to your favorite movie star".

"This 'closet indexing' can be measured by a metric known as 'active share' and can crimp outperformance by offering index returns with active management-level fees," said the note.


"Yet research suggests that truly active managers – those managing portfolios that look different from the index – do often outperform their benchmarks, even after fees. And even in the large cap space."

In additional to closet indexing, active managers are also hampered by 'asset bloat' and 'low conviction', said Ranger International.

"Asset bloat refers to the tendency of mutual fund performance to suffer as the fund grows in size. Fund inflows may become so large that a manager’s best ideas may become impractical to implement, or will be diluted by less attractive investments," said the note.

"Conviction refers to investing in so many stocks that the top 10 or 20 holdings do not represent a significant share of the portfolio. Not only do more stocks make the portfolio more like the broader market, but a large number of stocks dilutes the best ideas of active managers."

All three factors – closet indexing, asset bloat and low conviction – can culminate in 'portfolio drag' for active managers, said the note.

"Examining portfolio drag has important implications for evaluating active equity managers. That is, funds with less drag have better odds of outperforming their passive benchmarks," said the note.

"This news may not mean that the paparazzi will soon be chasing portfolio managers. But it may mean that investors will chase down more information before investing."

More to come:

Super objective set too low: ASFA

Antipodes IPO approaches $330m

Governance Institute hires CCO

NGS Super ditches CommInsure

New directors appointed at Super SA


'Closet indexing' crimping active returns
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