Closet indexing

Charging an active management fee on a portfolio that substantially matches the index a far cheaper fund already tracks.

Example

A fund charging 0.80 points over an index alternative, of which 85% of the weight matches that index, needs the differing 15% to add 5.33 points a year merely to break even.

Important

The test is whether the fee is proportionate to how different the portfolio is, not whether the fund calls itself active. A genuinely distinct portfolio at an active fee is a coherent proposition; the arithmetic only becomes damning as the overlap rises.

Related terms

• Expense ratio — The annual fee a fund charges, expressed as a percentage of the money you have in it.
• Index fund — A fund built to track a market index, such as a broad stock index, rather than to beat it.
• Active management — A fund manager, or you, picking specific investments in an attempt to beat a benchmark.
• Look-through — Reading a fund's actual holdings and their weights, rather than its name or category, to establish what exposure you hold.

Lessons that explain it

• Appraising one fund: the holdings file, the rules, and the gap to the index — Seven checks, in order of how much they change what you own. The two everybody runs - the name and the expense ratio - are the two cheapest, and the one nobody runs is where the exposure lives. (14 min)

All 578 terms in the Investing glossary