Investing March 23, 2016

Active Funds Can Outperform Passive Funds

“Industry-wide averages can be misleading, and may be doing investors a disservice by giving them the perception that all active funds cannot outperform passive funds, which is simply not true,” says Timothy Cohen at Fidelity.
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By using two simple, objective filters—mutual funds with lower fees from the five largest fund families by assets—the average actively managed U.S. large-cap equity fund outperformed its benchmark in 2015, after fees, by 0.70% (or 70 basis points), according to new research by Fidelity Investments.

The research report, “Some Active Funds Rise Above a Tough Year,” says this same subset of funds also outperformed their benchmarks by 0.18% per year from 1992 through 2015, while the average subset of passive index fund slightly trailed its benchmark by 0.04%. While 0.18% per year of outperformance may not seem like a lot, Fidelity says, this may translate to more money to spend, or a longer and more secure retirement.

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As a hypothetical illustration, suppose a retirement investor saves $5,000 per year in two different accounts, one with 0.18% of annual excess return and one with –0.04% of annual excess return (assuming returns are net of fees and a constant “benchmark” return of 7%). At the end of 40 years, the balance for the account with 0.18% of excess return would be more than $64,000 higher than the other account, essentially earning an additional 6% of cumulative return.

“We believe that market outperformance—through the compounding of returns—can help shareholders increase their ability to achieve their most important financial goals,” says Timothy Cohen, chief investment officer at Fidelity Investments. “Excess returns can be an important driver of wealth creation, and actively managed funds offer you the opportunity to outperform the market.”

NEXT: Long-term results

Although past performance is no guarantee of future results, these filters have been remarkably consistent in identifying sets of funds with above-average relative performance over time. For rolling three-year returns, the average actively managed fund selected by both filters beat the industry average a full 98% of the time from 1992 through 2015. In addition, a statistical test indicates one can be 99% certain that the historical long-term outperformance of the filtered average fund relative to the industry is significant.

Fidelity’s research also reveals that in the other largest equity fund categories (international large cap and U.S. small cap) active managers had a better record of outperforming their benchmarks, even without applying the two simple filters. Actively managed international large-cap funds outperformed their benchmarks by 0.85% per year and U.S. small-cap funds outperformed their benchmarks by 0.99% per year.

“Industry-wide averages can be misleading, and may be doing investors a disservice by giving them the perception that all active funds cannot outperform passive funds, which is simply not true,” says Cohen. “We believe the results of applying certain straightforward and objective filters can be a helpful starting point for investors seeking to identify above-average actively managed equity funds that beat their benchmarks.”

The report can be viewed here.
Compliance March 23, 2016

Lehman Again Granted Victory in Stock Drop Suit

Reviewing the case in light of new pleading standards set by the Supreme Court decision in Fifth Third, a court again found participants in a Lehman Brothers retirement plan did not prove a fiduciary breach.
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A federal appellate court has again affirmed a decision that participants in Lehman Brothers’ retirement plan did not plausibly argue that the company breached its fiduciary duty by keeping company stock in the plan when it was not prudent to do so.

In 2013, the 2nd U.S. Circuit Court of Appeals upheld an earlier ruling by the U.S. District Court for the Southern District of New York to dismiss the case of Rinehart v. Akers. That ruling was based on the presumption of prudence established in a 1995 decision in Moench v. Robertson. However, following the U.S. Supreme Court’s decision in Fifth Third v. Dudenhoeffer, invalidating the presumption of prudence, the Supreme Court sent the case back to the 2nd Circuit, which then sent the case back to the district court.

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In 2015, the district court again found the plaintiffs failed to allege sufficiently that the Lehman Brothers’ plan committee violated their Employee Retirement Income Security Act (ERISA) duties. The 2nd Circuit affirmed the district court’s decision.

The appellate court noted that while the Supreme Court made clear in Fifth Third that there should be no special presumption of prudence for employee stock ownership plan (ESOP) fiduciaries, “allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or under-valuing stock are implausible as a general rule, at least in the absence of special circumstances.” In addition, for claims alleging a fiduciary breach based on non-public information, the high court held that plaintiffs must plausibly allege an alternative action fiduciaries could have taken and would not have viewed as more harmful to the plan than helpful.

NEXT: Arguments rejected

The plaintiffs in Rinehart argued their case included “special circumstances,” pointing to Securities and Exchange Commission (SEC) orders issued in July 2008 prohibiting the short-selling of securities of certain financial institutions, including Lehman. The 2nd Circuit rejected this argument, saying the orders speak only conditionally about potential market effects resulting from short-sales and do not purport to describe then-existing market conditions. It agreed with the district court that the only plausible inference supported by the plaintiffs’ complaint is that the market processed any risks identified in the SEC’s orders as it would have any public information.

The appellate court also rejected the plaintiffs’ argument that had the retirement plan committee conducted an appropriate independent investigation into the riskiness of Lehman stock, it would have uncovered non-public information revealing the imprudence of investing in the stock. The court said the case includes no specific allegations about what lines of inquiry would have revealed this information, or who would have disclosed it.

In addition, the 2nd Circuit agreed with the district court that the complaint does not plausibly plead facts that show a prudent fiduciary would not have viewed disclosure of non-public information or ceasing to buy Lehman stock as more likely to harm the plan than help it, as dictated by the Fifth Third decision.

The latest opinion in Rinehart v. Akers is here.

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