Investment funds follow two distinct strategies – active management and passive management.
Active managers seek to find value in the market by owning stocks and assets that will give a higher return. That requires a big investment in research and analysis and this is reflected in higher average Annual Management Charges [AMC].
Passive managers believe that market returns cannot be improved on over the long term and so they do not waste money on expensive research. Instead, they seek to track various indices and they are happy that on average they will still get a good average return with lower AMCs.
The difference between charges can be significant and it has become apparent that some fund managers are marketing their funds as ‘active’ and charging a higher AMC when in fact they are simply tracking indices in passive mode and pocketing the difference in charges. These funds are classed as “closet trackers”.
In February 2016, ESMA [the European Securities and Markets Authority] published details of its supervisory work on closet index tracking funds. It began its investigation of the asset management industry as a result of concerns that the practice may harm investors who may not receive the service or risk/return profile to which they agreed based on the fund’s disclosure documents [KIIDS]. From their initial sample analysis of 2,600 funds for the period 2012-2014, it concluded that between 5% and 15% of equity funds could potentially be closet trackers.
Dublin is one of the largest European centres for funds and the Central Bank of Ireland (CBI) has reviewed 2,550 Ireland-domiciled funds and is investigating 182 UCITS funds it suspects of being “closet trackers”. It has investigated 62 of the funds so far and has taken action against 57 of them.
On 18 July, Patricia Dunne, head of the Securities and Markets supervision division, revealed the CBI is forcing implicated firms to amend their Prospectus and KIID. It must then be sent to all investors together with details of the Regulator’s finding.
Those who need changes must do so, and submit them to CBI, by 31 March 2020.