A Closet Index Carol

Does alleged index hugger American Century Value really belong on the naughty list?

December 28, 2021

Last month, a law firm filed a class action lawsuit alleging that the $2.4B AUM American Century Value Fund (TWVLX) is a “closet indexer” (or was, from October 2018 to September 2021).

We hate to play “Scrooge” this soon after Christmas, but we’re just not seeing it. (And neither are some other folks at Barron’s). In fact, we were tempted to bring back our Chart of the Week format just to highlight how much basic charts raise questions about the claim.

But Christmas is a time of giving, and as long-time proponents of robust, thorough analysis, we see no reason to stop with one chart when we can give you a couple more.

He’s Making a List…

The basics of closet indexing are simple: a fund claims to be actively managed, which merits charging higher fees. But behind the scenes, they try to closely mirror the benchmark, reducing their management costs and overhead.

The lawsuit makes two very specific additional complaints based on the three-year period October 2018 – September 2021:

  1. The fund’s 97% R-Squared means that “the strength of the relationship between the Fund and its benchmark, the Russell 1000 Value Index, is very high. Such a strong relationship indicates that the investment advisor’s investment strategy is adding little or no value to the Fund’s performance.

  2. The fund’s negative alpha (-1.57% for the period) “further illustrates that the investment advisor’s investment strategy is adding no value to the Fund’s performance.

Keeping the parameters outlined above, we took a look at 114 live mutual funds in Morningstar’s Large Value category with AUM greater than $1B (index funds removed – our interest was in active management) and plotted them with American Century Value as the origin on the chart. There are a significant number of funds in the universe with higher R-Squared, and a significant number of funds with lower alpha.

And overall, 16 funds have numbers that push them into the lower right-hand corner, where there is a theoretically better case for closet indexing per the logic of the complaint. If American Century Value was on Santa’s Naughty list this year, they can at least say they had plenty of company.

Naughty or Nice?

Santa’s ‘Naughty or Nice’ list is about behavior, so let’s turn to returns-based style analysis (RBSA) to see how the fund was behaving during the period. The chart below compares the fund’s Style Exposures against the Russell 6 style indices, to that of the benchmark and all large value funds in Morningstar with AUM greater than $1B. The peer average’s estimated style profile sure come a lot closer to resembling the benchmark than the American Century Value fund did.

If anything, the American Century Value fund looks like an outlier versus its peer group and benchmark, when it comes to its overall style allocation. In other words, the American Century Value fund did indeed underperform in the period specified, but from our initial review, closet indexing doesn’t appear to be part of the equation.

Checking it Twice

As we said before, we continue to be advocates for robust, thorough analysis using the best quantitative methods and tools available. In other words, if Santa can check his list twice, we can, too.

So, enjoy the rest of your holiday season, and join us in the new year as we kick things off with a webinar that dives deeper into the fund surveillance and monitoring. We’ll use the same quantitative methods we provide to due diligence teams, government regulatory agencies, and fiduciaries across the industry when they’re deciding who’s been naughty or nice.

Happy Holidays from MPI!


MPI conducts performance-based analyses and, beyond any public information, does not claim to know or insinuate what the actual strategy, positions or holdings of the funds discussed are, nor are we commenting on the quality or merits of the strategies. This analysis is purely returns-based and does not reflect actual holdings. Deviations between our analysis and the actual holdings and/or management decisions made by funds are expected and inherent in any quantitative analysis. MPI makes no warranties or guarantees as to the accuracy of this statistical analysis, nor does it take any responsibility for investment decisions made by any parties based on this analysis.

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