According to a report by Casey Quirk of Deloitte, 72% of money invested into funds went into passive funds in 2015. While some may see this as a strong case for passive investing, it is not that simple for plan sponsors.
Active investing attempts to exceed the stock market, whereas passive investing involves investing in an index fund that follows one of the major indices, such as the S&P 500 or Dow Jones. Passive investment portfolio managers do not make decisions about which securities to buy and sell.
Over the past twenty years, the trend has shown an increase toward passive investment strategies. Since 1993, there has been a net inflow of dollars into passive mutual funds and exchange-traded funds. Conversely, since 2016 there has been a net outflow of dollars from actively-managed funds.
What is the reason for this trend? The biggest driver seems to be the growing recognition that market averages are tough to beat.
Outperforming the Index
The Wall Street Journal published an article highlighting the percentage of actively-managed company mutual funds that beat the S&P 500 Index over various time spans. The chart summarized 1, 3, 5, 10, 15, 20 and 25 years, ending on June 30, 2016. The 10-year time segment was the only instance when the percentage of actively-managed funds exceeded the S&P 500 by more than 30%. Over other time periods, the proportion of actively-managed funds that exceeded the stock market ranged from 11%-25%.
Furthermore, out of all the actively-managed stock funds over the 10-year period ending on December 31, 2005, only seven beat the average performed in the subsequent decade.
Fighting the Odds
In the face of this data, why is it important to include actively-managed stock funds in your retirement plan’s investment lineup? For starters, you are providing choice based on participants’ risk tolerance, investment objectives and investment strategies to meet the perceived needs of plan participants. As the Wall Street Journal stated in its compilation of performance data, “the prospect of beating the market and maximizing your investment potential is a tantalizing one.”
If some participants are willing to fight the odds against superior returns with an active manager, is it a manager’s place to deny them that opportunity? Not necessarily—assuming that you have carefully researched the actively-managed funds and that you provide participants with sufficient information to make an informed choice.
Furthermore, passive funds in a down market will suffer the same fate as the market, while active funds can cushion the blow by moving to cash. In addition, managers of actively-managed funds may find good investments in niche stock sectors where stocks are more illiquid and fewer analysts are paying attention.
Getting it Right
In addition to monitoring the performance of your plan’s funds, keep an eye on how your participants allocate their retirement dollars. If you offer actively-managed funds and a significant number of participants appear to be taking on greater risks, then it may be time to increase investment education programs to assist participants in planning their investment strategies.