Regulation alone is unlikely to adequately address the threat of so-called ‘closet tracker’ funds being mis-sold to investors, despite initial steps by the EU’s main financial body.
Last week, the European Securities and Markets Agency (Esma) said up to 15 per cent of equity funds it surveyed could be charging active fund fees while doing little more than tracking a benchmark.
Intervention against closet tracking in various forms has begun in Norway, Sweden and the Netherlands, and JPMorgan analysts recently concluded that the FCA’s asset management market study could also shine a light on the practice.
The FCA is also set to address the issue in its ‘meeting investors’ expectations’ thematic review of the funds industry, but many are unconvinced this will suffice.
The Investment Association’s interim chief executive, Guy Sears, told a transparency conference last week: “The FCA is bound to, if it has not already, carry out further checks against the [funds’] aims and objectives that have been set and what actually has been charged.”
However, Rayner Spencer Mills Research (RSMR) director Ken Rayner said the regulator would be unable to put a stop to closet tracking without straying far beyond its remit.
He said: “I don’t think the FCA could say, ‘all these funds on this list are closet trackers, so you have to reprice them.’ You can’t dictate how a business is run.
“The best the FCA can do is ask for clarity on objective and purpose and that documents make sure the clients understand what they are getting or what they are likely to get.”
Sean Tuffy, senior vice president for investor services at Brown Brothers Harriman, thought the Esma data would “raise the temperature a bit more” but said defining closet trackers could be fraught with complexity, particularly as the lines between active and passive become more blurred.
“I think that a lot of active managers are going to be pushed to prove that they aren’t closet trackers,” he said.
He added: “This could get tricky with the emerging smart beta trend. So, it will be very important to see how closet tracking is defined and how regulators will attack the issue.”
Both Rory Maguire, managing director at ratings agency Fundhouse, and RSMR’s Mr Rayner believed market forces could play a greater role in eradicating closet trackers.
Mr Maguire said: “I don’t think you can regulate how active managers need to be. If you come in with regulation for managers to show how active they are, I don’t know if that forces a good outcome.”
He stressed that ratings agencies, as well as investment intermediaries, should highlight funds that were being mis-sold as active and steer investors away from these.
He also claimed competition would be the best defence against mis-selling “with clients voting with their feet”.
Esma’s study analysed 1,251 Ucits vehicles across the EU, from 2012 to 2014 using active share, tracking error and R2. It then compared results against fund literature, finding enough evidence that closet tracking existed for further examination by domestic regulators.