Closet Index Fund

closet index fund

An investment company that claims to actively manage its portfolio but in reality emulates a market index such as the S&P 500. Closet index funds generally charge sales fees and annual expenses that are typical for an actively managed fund.

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Closet Index Fund

A mutual fund that is actively managed in theory, but more or less tracks a benchmark stock index. Closet index funds generally exist because their managers believe it is safer to generally track indices rather than take on the greater risks incumbent with more active management. Closet index funds do not advertise themselves as such, but one may determine whether a mutual fund is one by comparing its R square to a given index. Some advisors counsel staying away from closet index funds as they carry fees and commissions associated with mutual funds, and one can directly invest in an index for less expense, while achieving the same result.

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Closet index fund. A closet index fund is an actively managed mutual fund whose portfolio includes many of the securities in its benchmark index but whose expense ratio is higher than that of a true index fund or exchange traded fund (ETF) tracking the same index.

As the name suggests, a closet index fund may not publicize how closely its portfolio tracks its benchmark index. But the investment objectives listed in the fund's prospectus may reveal that the fund seeks to provide results at least as good as its benchmark.

One way to identify a closet index fund is to consider the fund's R-square, which measures the extent to which the fund's return is determined by changes in its benchmark. The closer to 100 the R-square is, the greater the parallels between a fund's portfolio and the components of the index.