PEI believes plan sponsors can prudently use both actively managed and passively managed products in their retirement plans. From a plan design perspective, offering a suite of both active and passive products allows participants the option of building a diverse portfolio with the investment approach of their preference.
However, many plan sponsors have sought guidance on how to evaluate the role of actively managed funds in their retirement plans’ lineup, often citing performance or fee concerns relative to passively managed products that have fared well on the back of a strong market recovery post-2008.
To address these specific concerns, PEI wanted to highlight the following perspectives:
Regarding performance, actively managed funds’ relative performance often comes in cycles.
- For example, during the trailing five-year period ending December 2016, only 18% of large value funds outperformed the index.
- However, during the trailing five-year period ending June 2011, 63% of large value funds outperformed the benchmark. This period includes the global financial crisis, indicating active management has done a better job than the benchmark through the downturns of a market cycle.
While similar periods of out and underperformance are common across asset classes, there are other nuances for markets outside of domestic equity that make comparing the performance of actively managed funds to passive benchmarks less appropriate. For example, an international equity manager may or may not utilize currency hedging or a bond manager might or might not invest in high-yield bonds, making the category less homogenous than many domestic equity categories and more difficult to compare relative to a single benchmark.
Regarding fees, both actively managed funds and passively managed funds should be reasonably priced.
- For example, within Morningstar’s large-value peer group of funds (including all possible share classes), fees range from 0.13% to 2.99%, with the median actively managed fund’s expense ratio is 1.00%.
- Among passively managed large-value funds, expenses range from 0.05% to 2.78%, with a median expense ratio of 0.46%.
While this data is representative of just one category, fees range widely across other peer groups, confirming there are passive products that are more expensive than active products and vice versa. ERISA does not direct a plan sponsor to only choose the least expensive investment options, but does require a level of prudence in evaluating investment options comprehensively, which applies to both active and passive investments. Plan sponsors need to incorporate a cost analysis of investment options, and analyze performance net-of-fees, for investments of any type.
Plan Sponsors have a duty to offer a reasonable array of investments and to monitor those investments. In PEI’s view, the process to offer a selection of investments for participants to invest in should be well-documented and regularly reviewed. Our recommendation continues to be that plan sponsors should provide a selection of both active and passive options to act as building blocks that allow participants the capability to create a well-diversified portfolio from either or both types of investments.