* Swedish regulator names 25 funds but issues no penalties
* Peer regulators also looking for 'index huggers'
* Britain's FCA in focus after tough report on industry
By Simon Jessop, Mia Shanley and Terje Solsvik
LONDON/STOCKHOLM/OSLO, Jan 12 Scandinavia is
raising the pressure on financial regulators across Europe to
get tough on allegations of "index hugging" - where active
investment funds may be misleading clients by covertly tracking
a stock index.
Sweden's financial regulator has named 25 active funds run
by some of the region's biggest providers which appeared largely
to mirror benchmark indices, while in Norway a consumer watchdog
is seeking compensation for investors from the asset management
arm of DNB - a lawsuit the bank is contesting.
Consumers have long suspected that some active funds, which
charge higher fees to scour markets for the best stock picks,
may be "closet" trackers - offering little more service than
cheaper passive funds which hold shares merely according to
their weight in the underlying index.
Last year the European Union's securities regulator said up
to 15 percent of active funds seemed to mimic their
benchmark. Watchdogs in Britain, Germany, Denmark,
Sweden and Norway have all looked into the issue, but few have
revealed full details of their investigations and no asset
manager has yet been forced to compensate investors.
Now the lead given in Scandinavia may encourage more
European regulators to go public, even though index hugging can
be difficult to prove.
Amin Rajan of CREATE Research said central banks' policies
of flooding their economies with cash, much of which has ended
up inflating stock prices generally, has made the problem worse.
"The regulators are likely to adopt a much more muscular
approach, because the extent of closet tracking has reached a
high proportion of funds as managers have found it difficult to
beat their market benchmarks," he said.
By tracking an index, an active manager is less likely to
stand out as a poor performer and lose clients. But the investor
is paying extra in the hope that the manager will outperform the
index, not just track it; active funds typically charge 0.75-2.0
percent of assets they manage a year, compared with as little as
0.1 percent for a passive fund.
REPLICATING THE INDEX
The main measures in question are active share - the
percentage of a fund's portfolio that differs from the
underlying index - and tracking error - the difference between
its returns and those of the benchmark.
When Sweden's Finansinspektionen (FI) regulator published
its list in November, it named funds whose composition
apparently closely replicated the index on which their
performance was measured. They included offerings from
Handelsbanken, SEB, Swedbank Robur
Carl Cederschiöld, CEO of Handelsbanken Asset Management,
said its funds on the list have an active share above or in line
with competitors. "We think this is fair to investors," he told
SEB said it had merged two of the funds named by FI and that
the new product had a significantly higher active share of above
50 percent. To improve transparency, SEB was publishing active
share figures monthly, a spokeswoman for the bank added.
Swedbank Robur said its funds have been actively managed and
that it has openly shown various risk figures for them. Skandia
declined to comment.
FI's list followed pressure from shareholder groups which
wanted the regulator to crack down on the behaviour and be clear
about which funds were less active.
However, it did not refer to the funds as index huggers,
even though most had active shares below the 60 percent defined
as the minimum level by some academics.
Since its report, based on an investigation which began in
2013, FI has said activity in many of the funds has gone up
while fees have come down, declaring itself happy as long as
they are clear with investors and charge them accordingly.
"It's important that they take their activity and
information they give about the fund and put that together -
does the information about the fund match our activity level?
What would a client expect?" said Erik Lindholm, deputy director
for consumer protection at FI, told Reuters.
The Swedish Shareholders' Association said it had not taken
any legal action on index hugging due to the high cost and
uncertain prospects of success. However, in neighbouring Norway,
a court ruled last week that it would allow a class action suit
to go ahead against DNB Asset Management.
Norway's Financial Supervisory Authority found in 2015 that
DNB had failed to provide sufficiently active management of a
flagship fund, even though it had been marketed as such and
customers had paid higher fees than for index funds.
At the time, the FSA ordered DNB to cut the fund's fees or
ensure it was actively managed. The bank responded with changes
to ensure the fund could continue to be classified as active,
but has also reduced fees, which it said was a response to
In the lawsuit, Norway's Consumer Council, a publicly
appointed watchdog, will demand repayment of about 690 million
crowns ($80 million) on behalf of 180,000 investors. The court
did not rule on the merits of the case itself.
"We believe DNB charged their clients for a service they
didn't deliver," Consumer Council chief Randi Flesland told
Reuters. "In our view, they must repay the extra fee."
DNB has repeatedly argued the fund was actively managed, and
rejected the compensation claim. A spokesman told Reuters the
bank is now considering whether to appeal the court's decision.
SOUND AND FURY
To take action, regulators have to prove index hugging but
some regard the active share and tracking error measures as too
blunt to be fair.
"At this stage, naming and shaming is all that they can do
because it's very difficult to define what active investing
actually means and at what point an active portfolio turns into
a closet-indexing portfolio," said CREATE Research's Rajan.
"But if the problem gets more widespread, I think we'll see
some enforcement actions," he added.
Rajan pointed to an interim report from the UK Financial
Conduct Authority which said fund investors were getting poor
value for money due to insufficient competition and a lack of
transparency on fees. "All that sound and fury
means they've really got to back it with action," he said.
The industry is defending itself. A report from the European
Fund and Asset Management Association in July said a wider range
of factors needed to be considered, including a fund's
objectives, the degree of risk tolerance and the research
efforts of the manager.
The British FCA said in April that while most funds were
doing what they said they would, it had found examples of those
with unclear product descriptions and had told them to improve.
After a 10-month investigation, Germany's Bafin regulator,
highlighted a couple of cases in December, but said the funds in
question were already charging lower fees and were not being
In Denmark, a report in April found funds at 22 banking
departments had active shares below 50 percent and tracking
errors under 3 percent. However, it declined to name the funds
and, after talking to them, decided no action need be taken.
Denmark's fund trade body has told its members to publish
active share and tracking error figures annually, however, and
an official at the regulator said it now looks at this on a case
by case basis, without giving details.
Bafin has also said it plans to new transparency rules from
mid-2017 so funds must give investors greater information about
their style of management, while Sweden may also follow suit.
($1 = 8.6231 Norwegian crowns)
(Additional reporting by Huw Jones in London, Andreas Kroener
in Frankfurt and Jacob Gronholt-Pedersen in Copenhagen; editing
by David Stamp)