Why Pay Your Manager for Doing Nothing?

Benchmarks such as the S&P 500 are the standard by which most mutual fund management careers live and die.

Some try to outperform the gauges at the risk of potentially outsized setbacks during periods of weakness.

Others seem content to never suffer a deeper loss than that of their fund's benchmark.

But why invest in an actively managed mutual fund that's simply trying to match the returns of the S&P 500 when there are plenty of low-fee index funds that invest in the benchmark's components?

The funds listed in the table below present themselves as being actively managed.

However, upon closer examination, they have been generating returns in recent years that are extremely close to those of the passively managed S&P 500 index funds -- though not everyone considers the S&P 500 to be passive.

The table was created by filtering TheStreet.com Ratings' database of open-end, broadly diversified stocks and balanced funds for those with returns close to that of the largest index fund.

Each fund on the list never strayed more than 0.4 percentage points, on average, from the Vanguard 500 Index Investors Fund.

The average returns of the "closet indexer" suspects are remarkably similar to those of the Vanguard index fund as well as to its S&P 500 benchmark, which appear for comparative purposes at the bottom of the table.

However, the similarities between the index funds and the closet index funds end in the expense ratio column: The average closet indexer is more than seven times the 18 basis points per annum levied by the Vanguard index fund. The expense ratios of the funds on the list vary by more than four times that of the index fund to more than 12 times the cost to investors.

Closet Indexers Actively managed funds that resemble a passively managed index
Name, Ticker, TheStreet.com rating grade	Annual Expense Ratio (%)	Objective	3-Mo. Total Return (%)	12-Mo. Total Return (%)	3-Yr. Annual Return (%)
American Beacon Balanced Ser (ABLSX) B	1.25	Balanced - Domestic	0.99	11.63	9.98
American Funds Inv Co of Amer B (AICBX) C+	1.34	Growth & Income	0.87	11.62	9.78
Columbia Large-Cap Enh Core Fd A (NMIAX) C+	0.83	Growth - Domestic	0.41	11.85	10.23
Credit Suisse Tr-Blue Chip (CUBCX) C+	1.53	Growth - Domestic	0.59	11.74	9.89
DWS Equity Part A (FLEPX) C	1.21	Growth & Income	0.79	11.32	9.78
Fidelity Adv Equity Income B (FEIBX) D+	1.90	Equity Income	0.62	11.70	9.93
ING Lord Abbett Affiliated S2 (ILATX) C-	1.25	Growth & Income	0.48	11.35	9.92
JennDry Dryden Large Cap Core Eq A (PTMAX) C	1.27	Growth - Domestic	0.97	11.76	10.16
Legg Mason Prt Investors Value B (SBINX) C	1.84	Growth - Domestic	0.58	11.95	9.59
Lord Abbett Affiliated Fund A (LAFFX) C-	0.80	Growth & Income	0.36	11.48	10.25
McMorgan Equity Investment Z (MCEZX) C+	1.02	Growth - Domestic	0.80	11.43	9.98
Principal Inv Prt LgCp Blend AdvPfd (PPZMX) C	1.32	Growth - Domestic	0.54	11.29	9.55
Putnam College Adv New Value B (N/A) B-	2.26	Balanced - Domestic	0.60	11.37	10.03
Putnam Fund for Gr & Inc A (PGRWX) C-	0.90	Growth & Income	0.43	11.98	9.84
SSgA IAM Shares Fd (SIAMX) C+	0.79	Growth - Domestic	0.58	12.03	9.56
T. Rowe Price Dividend Growth Fd (PRDGX) B-	0.75	Equity Income	0.87	12.05	10.25
TA IDEX Transamerica Value Bal A (ITAPX) C	1.63	Balanced - Domestic	0.95	11.42	9.60
Averages	1.29		0.67	11.65	9.90
S&P 500 Total Return Index			0.64	11.83	10.05
Vanguard 500 Index Inv (VFINX) C+	0.18	S&P 500 Index	0.60	11.67	9.91
Data as of 3/31/2007 Source: TheStreet.com Ratings

Although these funds have been closely mimicking the returns of the S&P 500 in recent years, they are not necessarily all "closet indexers." The correlations might just be spurious coincidental correlations for these particular time periods.

Investors, however, should regularly compare fund returns with the respective benchmarks. If close correlations between the two persist for any prolonged timeframes and you wind up paying management fees for passive performance, then perhaps it's time to switch to an index fund.