Index Huggers

Call This a Punishment?

Britain's FCA offers little redress and less transparency for investors.
Photographer: Simon Dawson/Bloomberg

Fund managers who ripped investors off by selling them actively-managed funds that merely tracked an index are to be punished by British regulators. But the amount of redress is paltry compared with the size of the alleged fouls. And the regulator isn't publicly identifying the wrongdoers. For shame.

Writing in Monday's Telegraph newspaper, Megan Butler, the Financial Conduct Authority's director of supervision for investment wholesale and specialist, said the watchdog reviewed 84 funds it suspected of misleading investors. Of those, 64 have been ordered to rewrite their marketing materials to be more truthful about the fact they are closer to passive funds in their investment behavior.

In addition, investors will receive 34 million pounds ($47 million) in compensation for being overcharged.

That's chicken-feed, given the scale of the misidentification the FCA itself has accused the fund management industry of perpetrating. In a June report, the regulator estimated that about 109 billion pounds is tied up in active funds that closely mirror the market and charge higher fees than passive products.

SCM Direct, the fund manager founded by Gina Miller, calculated that in 2014 investors in the 10 "worst-offending" index-huggers lost 346 million pounds in underperformance when compared with index trackers. The study, which analyzed 137 billion pounds of assets, argued that the losses could be as high as 803 million pounds for all individual investors.

Aggressively Passive

Europe's ETF market grew by 40 percent last year

Source: ETFGI

While the surge in demand for low-cost exchange-traded funds has driven down fees across the industry, fee competition among fund managers, as the FCA itself has pointed out, is negligible. By charging the higher fees associated with active funds but then simply mirroring a benchmark with only small changes, asset managers can reduce their workload to a minimum.  

Investors in these "expensive ‘partly active’ products" would get better value for money from passive funds, the FCA said.

It's not just a U.K. phenomenon. The European Securities and Markets Authority, which regulates investment management across the European Union, warned in 2016 about the risks of closet indexing; in November, it said it would seek data from national regulators as part of an ongoing industry review.

The FCA's enforcement action is to be applauded for the warning it sends to the asset management industry. But it doesn't go far enough.

The watchdog would better serve consumers by publishing a list of the funds it discovered in its investigation, both as a punishment for their wrongdoings and as a warning to others. As a U.S. Supreme Court Justice wrote more than a hundred years ago, sunlight is the best of disinfectants.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Mark Gilbert in London at

    To contact the editor responsible for this story:
    Edward Evans at

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