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Beware of the Closet Index Fund

Some actively managed mutual funds have portfolios that read like stock index funds, but their fees are higher.

Low-cost index funds are a genuine boon. Tracking broad or narrow sectors of the market, they are the perfect buy-and-hold investment for busy investors. What isn’t such a good deal are mutual funds that charge actively managed fund prices for index fund investments. These funds range from big names with well-known managers to smaller, more obscure funds. Their portfolios are nearly identical to that of an index fund. Why pay more for less return—when a plain vanilla, low-cost index fund can do the job just as well? You can identify and avoid these closet index funds by inspecting their portfolios under a microscope.

The popular image of fund managers as swashbuckling risk-takers simply doesn’t jive with reality. Institutional investors in charge of gigantic pension funds buy mutual funds that track sections of the market. Managers who stray from that safe niche could lose their asset management contracts and the fees that go with them. With corporate bean counters and institutional investors breathing down their necks, most fund managers can’t afford to fall too far behind the averages, resulting in big fund complexes and obsessed managers who are trying to beat their peers and track the indexes. Taking the risks required to beat the index by a wide margin might not pay off, so most managers don’t take them.

For those few managers who do ...