The degree of diversification an investor uses is a choice that fits within value investing as long as it does not rise to the level
of closet indexing («index huggers»).
And some mutual funds, especially those that are truly active funds instead
of closet index funds, actually have a chance of beating the index and can do so over extended periods of time.
Not exact matches
Much
of what goes on in money management in the professional rank is a form
of «
closet indexing.»
They are «
closet indexing» with the goal
of not underperforming by enough to get fired.
It appears that the under - performance
of active strategies is caused by «
closet indexing».
If the active share
of a fund is close to zero, then the fund is effectively a replica
of the
index, hence the term «
closet indexer.»
The impact
of capital loss (and
closet indexing) is validated by the chart below, which illustrates the cumulative performance
of $ 1.00 since September 2000 under two scenarios:
Closet indexing might stick to an
index in terms
of weighting, industry sector or geography.
The motivation for
closet indexing grows out
of years
of poor performance and the ongoing shift from active to passive management.
In other words, the vast majority
of professional investors are just
closet index funds charging high fees.
There are still trillions
of dollars captured by hedge funds,
closet indexing funds, high fee 401K plans and high fee investment advisors.
It is the weakness
of the
index to be able to allow
closet indexing to happen.
Bay Street's response to the Nortel fiasco
of contracting out the
index construction to S&P now seems like an impending loss in value for those
indexed or «
closet indexed» to the S&P TSX
index.
Closet indexing is the result
of active managers owning the market like an
index fund, but charging active management level fees.
As
of 2009 when the below chart ends, roughly half
of mutual fund assets are
indexed or
closet indexed [ii].
Your investments are too important to leave it at the mercy
of the market (
index funds or
closet index funds)
Thirteen major U.S. mutual fund companies have agreed to begin publishing data about how actively their funds are managed, following an investigation by the office
of the attorney general
of New York (NYAG) into the practice
of «
closet indexing,» NYAG announced Thursday.
A
closet index fund is when the fund manager is simply trying to follow an
index, which is a huge rip - off for you, since you could instead just buy an actual
index fund and pay an MER
of 0.5 % instead.
However, as a generalization I think it's pretty fair to say that the vast majority
of mutual funds are
closet -
indexing leaches that do no one any good (except for the management companies who charge the high fees).
Charlie Munger points out that «[With]
closet indexing, you're paying a manager a fortune and he has 85 %
of his assets invested parallel to the
indexes.
In this July 2006 research note titled Come out
of the
closet, or, show me the alpha James features a study that suggests
closet indexing accounts for nearly one third
of the US mutual fund industry.
He writes about how both
closet indexing and shooting for the stars are exposing financial planners» clients to undue risk: «In a recent issue
of Barron's, a money manager was quite critical
of a particular stock, but said he owned it, although he was «underweighted».
A good example
of the latter is «
closet tracking» also known as «
index hugging».