Abstract
This paper 1 discusses the need for legal measures to ensure a higher degree of investor protection against closet indexing. ‘Closet indexing’ refers to practices where a fund claims to attempt to beat the market, despite following a passive investment strategy in practice. Such practices may harm investors, who might end up paying higher fees than necessary while not receiving the service they expect. The analyses herein are based on the European legal framework for fund management and examine how this framework is applied in Scandinavian countries. Practices from Scandinavian countries reveal the need for legal measures to improve investor protection against closet indexing practices. In particular, the paper concludes that there is a need for a coordinated approach to identifying closet indexing and to securing a better interplay between the European legal framework for fund management and national rules on contract and tort law.
Highlights
Collective investment funds are popular among retail investors.[2]
The purpose of this paper is to investigate the need for legal measures to ensure a higher degree of investor protection against practices of closet indexing
Because there are no established, authoritative guidelines on what is required for a fund to be actively managed, the national authorities are left with a high level of discretion regarding further identification of closet index funds under the European legal framework for fund management
Summary
Collective investment funds are popular among retail investors.[2]. For investors with limited knowledge, time, or money, collective investment funds can provide diversification, liquidity, professional management, and other benefits. The investors’ legitimate expectations must be based on an analysis of information regarding the investment strategy of the fund and the cost of management.[26] Among the funds that are not explicitly defined as index tracking, there can be a range of different (active) investment strategies, e.g. depending on the degree of freedom in relation to the benchmark. A fund is a closet index fund when the investors’ legitimate expectations as to the degree of active management differ from the actual management of the fund The identification of this gap requires an overall evaluation of investor information documentation and the cost of the management service in light of the general responsibility to act in the investors’ best interests, as well as the threshold for closet indexing established by finance theory. To the author’s knowledge, there are no civil lawsuits based on closet indexing in Denmark
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