A note on closet-indexing

Actively managed equity mutual funds with returns that are highly correlated with popular stock market indices like the S&P 500 often are accused of “closet-indexing”. We ask whether a trading strategy that shorts these funds and buys “true” index funds makes money for investors. Using a sample of high-R² growth-and-income funds from the CRSP survivor bias free mutual fund file, we document that the Sharpe ratio of this trading strategy and the market Sharpe ratio are statistically indistinguishable in the 1991–2000 sample period. The result is consistent with the view that widespread closet-indexing does not exist in the mutual fund industry.