Do Mutual Fund Investors Get What They Pay For? The Legal Consequences of Closet Index Funds

73 Pages Posted: 24 Nov 2015

See all articles by Martijn Cremers

Martijn Cremers

University of Notre Dame; ECGI

Quinn Curtis

University of Virginia School of Law

Date Written: November 24, 2015

Abstract

Actively managed mutual funds sell the potential to beat the market by picking stocks that are expected to outperform passive benchmarks like the S&P 500. Funds that are marketed as active vary substantially in the degree to which their portfolio holdings actually differ from the holdings of passive index funds. A purportedly active fund with a portfolio that substantially overlaps with the market is known as a closet index fund. Since closet index funds charge considerably higher fees than true index funds but provide a substantially similar portfolio, they tend to be poor investment choices. This article presents empirical evidence on closet index funds, showing that more than 10% of U.S. mutual fund assets are currently invested in closet index funds and that high cost closet index funds substantially underperform their benchmarks. We argue that persistent closet indexing implicates a number of legal issues, including possible liability for fund advisors under the Securities Act and the Investment Company Act. We conclude by discussing potential adjustments to mutual fund disclosures that could help investors identify closet index funds.

Keywords: actively managed mutual funds, closet index funds, expense ratio, disclosure, legal liability, Securities Act, Investment Company Act

JEL Classification: G23, G24, G38, K22

Suggested Citation

Cremers, K. J. Martijn and Curtis, Quinn, Do Mutual Fund Investors Get What They Pay For? The Legal Consequences of Closet Index Funds (November 24, 2015). Available at SSRN: https://ssrn.com/abstract=2695133 or http://dx.doi.org/10.2139/ssrn.2695133

K. J. Martijn Cremers (Contact Author)

University of Notre Dame ( email )

P.O. Box 399
Notre Dame, IN 46556-0399
United States

ECGI ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Quinn Curtis

University of Virginia School of Law ( email )

580 Massie Road
Charlottesville, VA 22903
United States

HOME PAGE: http://https://www.law.virginia.edu/faculty/profile/qc3q/2298852

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