DEFINITION of 'Closet Indexing'

A portfolio strategy used by some portfolio managers to achieve returns similar to those of their benchmark index, without exactly replicating the index.

BREAKING DOWN 'Closet Indexing'

A portfolio manager practicing closet indexing might stick to an index in terms of weighting, industry sector or geography. A manager's performance is usually compared to that of his or her benchmark index, so there is an incentive for managers to gain returns that are at least similar to the index.

Closet indexing is often viewed negatively by investors because they could simply choose an index fund and pay lower fees. Not surprisingly, "closet" indexing is so named because these practices are often not publicly announced, but a close examination of a fund's prospectus can sometimes uncover which funds are practicing closet indexing. Watch for funds with high MERs and holdings that look quite similar to the fund's benchmark index.

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