Friday, April 11, 2008

Closet Indexing By Mutual Funds: Worse Than We Thought? - Seeking Alpha

Seeking Alpha has an important article on ETFs being held within mutual funds.

Closet Indexing By Mutual Funds: Worse Than We Thought? - Seeking Alpha: ". is extraordinary how many traditional long-only mutual funds hold ETFs, either to equitize their cash or to get the market return and then just layer on fees. You may not see the ETFs held during the reporting periods, but certainly inside those periods."
One more look-in which sums up the issue:
"First, "'s not inherently wrong for mutual fund managers to equitize cash with ETFs. Depending on a manager's investment discipline and conditions in the relevant asset class, it can be perfectly sensible to combine a set of active opportunities and ETFs for portfolio completion....

But Keenan's remarks reveal a couple serious -- and potentially related -- problems:

(1) reporting-period manipulation designed to conceal the fact that managers are equitizing assets using ETFs and

(2) the cynical laziness of earning market returns and layering on active-management fees."

The part about the funds not holding the ETFs during reporting periods is example 1,734,651 of an agency cost. Specifically this "window dressing" increases costs merely to make it look like the managers are somehow adding value.

Good stuff as always. SeekingAlpha is well worth a look.

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