When it comes to investing, many active funds claim to offer the edge of professional management, but a surprising number are little more than glorified index funds. These so-called “closet indexers” mirror the performance of a benchmark while charging the high fees of active management, leaving investors with the worst of both worlds—passive returns at active costs.
What Is Closet Indexing?
Closet indexing occurs when an actively managed fund closely mimics a benchmark index, like the S&P 500, while charging the higher fees associated with active management. Instead of making meaningful investment decisions to outperform the index, these funds hold a large number of stocks that align closely with the index’s composition. As a result, they deliver index-like performance but with added costs, leaving investors paying a premium for minimal differentiation.
This practice undermines the value of true active management and highlights the importance of understanding what you’re paying for in your investments.
Real life example
The graphic below highlights the top holdings of the Satrix MSCI World Feeder Fund, which costs 0.35% per annum, compared to the top holdings of a rival active manager investing in global equities.

Despite charging an active management fee of 1.4% per annum, the overlap in holdings is significant, raising the question: are you truly getting active management, or are you paying a premium for what’s essentially a more expensive version of an index fund?
With such similar holdings, we would expect very similar behavior. Let’s take a look at the past 3 years of performance for the active fund compared to the Satrix Passive Index:

While the performance is very similar, there is a noticeable drag on the active fund.
The Case for True Active Management
True active management requires a fund manager to take meaningful positions, often focusing on a small, carefully selected set of stocks that differ from an index. This is measured by active share, a metric showing how much a portfolio differs from its benchmark.
Research shows that higher active share managers—those who deviate significantly from the index—have a greater chance of outperforming. However, with greater potential for performance comes greater volatility, which can test investor patience. It also means greater potential for underperformance.
The data is very clear—the vast majority of active managers fail to outperform the index over meaningful periods. If you’re going to choose active management, you need to find a manager with exceptional ability, akin to someone like Warren Buffett.
Avoiding the Trap of Closet Indexers
If you’re considering active management, here’s how to ensure you’re getting real value for your fees:
- Check Active Share: Funds with high active share own fewer positions and differ significantly from the index. This makes them true active funds.
- Understand the Portfolio: Managers who concentrate on a small number of uncorrelated stocks are more transparent and easier to evaluate.
- Beware of Tracking Error: While high active share is critical, you don’t want a manager making wild bets unrelated to the benchmark. Balance is key.
Why This Matters to You
Investing isn’t just about picking the right funds; it’s about understanding what you’re paying for. If your active funds behave like the index but cost more, you’re getting the worst of both worlds—passive performance with active fees..
Don’t be a closet indexer.
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