The tidal surge of funds flowing from actively managed funds into passive funds reached a tipping point in 2019, when Morningstar preliminary data indicated that passive U.S. equity assets would surpass active equity assets for the first time. This inflection point was widely anticipated. Over the prior decade, active domestic equity funds leaked $1.3 trillion in outflows, while their passively managed counterparts logged nearly $1.4 trillion in the opposite direction.
Reasons to Include Actively Managed Funds
Actively managed funds may have higher fees than their passive counterparts, but sometimes the active management may result in outperformance. Active fund managers may do a good job defending against — or recovering from — downturns, even if they do not outperform during bull markets. They might accomplish this with a slightly more conservative blend of investments or an ability to strategically add undervalued assets during down markets that they believe will juice returns when economic conditions improve. Alternatively, a passive index fund is built to “own the market” by mirroring it’s benchmark (and performance), less the internal fund expense.
A Poor Reason to Completely Exclude Actively Managed Funds
The lower fees typically charged by passive funds are self-evidently beneficial for participants, allowing more of their contributions to grow over time. But be cautious, excluding actively managed funds in favor of their lower-priced counterparts, doesn’t provide ironclad protection from a 401(k)-related lawsuit.
For instance, in 2019 a $3.2 billion suit against healthcare network Community Health Systems Inc. alleged an index fund included in the organization’s plan lagged its benchmark by an average of more than 9 basis points, while similar index funds lagged by approximately 1 to 2 basis points over the same period of time. And this breach of fiduciary duty, the plaintiffs claimed, led to losses in participants’ retirement savings. A settlement was reached in the case. The mere provision of an index fund did not protect these fiduciaries.
Beware the Wolf in Sheep’s Clothing
Plan sponsors may want to give greater scrutiny to certain actively managed funds with a low active share percentage. In some cases, such a fund could act as a closet indexer, making it more difficult for its performance to justify higher fees. And if so, may constitute a worthwhile candidate for exclusion from your plan.
No One-Size-Fits-All Answer
Constructing a retirement plan investment menu offering a wide array of choice, performance and risk characteristics requires care and consideration. But remember that there’s no ERISA mandate to always select the lowest cost funds. Instead, fiduciaries should make a reasoned evaluation of whether a fund’s offerings and fees are justified by its performance and value for participants.
As a Fiduciary Consultant, MCF works with the Retirement Committee to meet their duties of providing participants with a broad range of competitively priced investment offerings in different asset classes and styles of management (active + passive) allowing participants to appropriately diversify according to their own personal goals and risk tolerance.
IMPORTANT DISCLOSURE INFORMATION
MCF Advisors, LLC (“MCF”) is an SEC-registered investment adviser. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by MCF), or any non-investment related content, made reference to directly or indirectly in this presentation will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this presentation serves as the receipt of, or as a substitute for, personalized investment advice from MCF. To the extent that a reader has any questions regarding the applicability of any specific issue discussed herein to his/her/its individual situation, he/she/it is encouraged to consult with the professional advisor of his/her/its choosing. MCF is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of MCF’s current written disclosure statement discussing our advisory services and fees is available upon request. If you are an MCF client, please remember to contact MCF in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing / evaluating / revising our previous recommendations and/or services. Please click here to review our full disclosure.