Investing August 23, 2017

Passively Managed Funds Trounce Actively Managed Funds

Morningstar reports that among active U.S. stock funds, the worst performers were small blend funds, of which only 32% beat their benchmarks in the past year.
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Morningstar’s mid-year 2017 Active/Passive Barometer found that most actively managed funds have failed to survive and beat their benchmarks, especially for funds with longer time horizons. The average dollar in passively managed funds typically outperforms the average dollar invested in actively managed funds, the research firm finds. Low-cost funds performed better than higher-cost funds.

Nonetheless, when compared to the trailing 12 months ended June 30, 2016, active funds’ success increased substantially in 10 of 12 categories in the year ended June 30, 2017. Forty-nine percent of active U.S. stock funds beat their composite passive benchmark in the 12-month period ended June 30, 2017, whereas only 26% had done so the year before.

Active funds in the large-, mid- and small-value categories had a combined success rate of 57% relative to their passive peers over the last 12 months.

Among active U.S. stock funds, the worst performers were small blend funds, of which only 32% beat their benchmarks in the past year. Last year, 46% of small blend funds beat their benchmark. The best performers among active U.S. stock funds were small value and small growth funds, of which 58% and 61%, respectively, beat their benchmarks.

NEXT: Results by Category
Over the long term, actively managed U.S. large-cap funds have not performed as well as mid- and small-cap U.S. equity funds. Over the 15-year period ended June 30, 2017, only 48% of large-cap funds survived. Among the lowest-cost funds, 57% survived, but this declined to 29% for the highest-cost funds.

The large growth category has also been particularly difficult for active managers. Less than half of the actively managed large growth funds that existed 15 years ago survived, and only 7.1% managed to both survive and beat their average passively managed peers.

Value managers saw some of the most meaningful increases in their short-term success rates. Active funds in the large-, mid- and small-cap value categories experienced year-over-year upticks in their trailing one-year success rates of 44.1%, 48.1% and 28.2%, respectively. Morningstar says this is due to the fact that over the year ended December 31, 2016, the Russell 3000 Value Index outperformed the Russell 3000 Growth Index by more than 10 percentage points.

Success rates for actively managed U.S. mid-cap funds have tended to be more diverse and variable than for U.S. large- and small-cap funds. Morningstar says this is because many mid-cap funds bleed into other market cap segments or styles.

Investors in the lowest-cost quartile of actively managed foreign large blend funds had the fourth-best success rate of the subgroups Morningstar examined. Over the 10-year period ended June 30, 2017, 38.6% of these funds survived and outperformed their average passive peers. Over the trailing 20 years, more than 80% of the lowest-cost actively managed foreign large blend funds survived and outperformed their passive peers.

Managers in the intermediate-term actively managed bond category saw the most substantial improvement in their one-year success rate; 85% of these funds survived and outperformed their passive peers.

Morningstar's mid-year 2017 Active/Passive Barometer report can be downloaded here.
Products August 22, 2017

Report Addresses Common BICE Questions

A new report answers some common questions plan sponsors may have about the BICE rule.
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As the Department of Labor’s (DOL) fiduciary rule goes through its phased implementation, some financial institutions and advisers will take on new requirements regarding the delivery of investment advice to retirement plan participants and other stakeholders. Some may choose to stop offering investment advice all together.

Built into the rule, however, is the Best-Interest Contract Exemption (BICE). This part of the expanding fiduciary regulations aims to protect plan participants from receiving costly or conflicting investment advice, while allowing service providers and advisers to keep offering retirement plan investment advice under existing compensation structures, as long as they meet certain fairness standards under the Employee Retirement Income Security Act (ERISA). BICE rules are very important for plan sponsors and advisers to consider when interacting with various vendors. 

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An article titled “Everything You Wanted to Know About BICE But Were Afraid to Ask,” was recently published by Benefits Quarterly, a publication of the International Society of Certified Employee Benefit Specialists (ISCEBS). 

Attorneys from Jackson Lewis, who authored the report, suggest plan sponsors begin by asking their retirement plan investment advisers to confirm their status as fiduciaries and to provide proper documentation. The organization also offers some insight into what is expected of a fiduciary working under the BICE. According to the report, a financial institution must “adhere to impartial standards of fiduciary conduct which include providing advice that is in the best interests of the investor and his or her financial objectives without regard to the financial interests of the adviser.” The fiduciary must also “implement policies and procedures designed to prevent violations of fiduciary standards, and adequately disclose fees, compensation and material conflicts of interest with respect to investment recommendations.” 

In an important sense, the ultimate execution of these requirements remains the responsibility of plan sponsors, which is why the report emphasizes that plan sponsors now “need to be more aware of who is being paid and how.” Sponsors have to determine whether all fees for providing financial advice are reasonable.

Plan fiduciaries also have to be on the lookout for potential conflicts of interest. According to the report, a “conflict of interest exists (for purpose of BICE) when an adviser has a financial interest that a reasonable person would conclude could affect the exercise of its best judgement as a fiduciary in rendering advice to a retirement investor.” These conflicts of interest need to be disclosed and proper safeguards must be put in place to protect the participant if the adviser intends to use the BICE protection. A person must be identified by name or function who is responsible for addressing conflicts and monitoring adherence to standards of impartial conduct. Those who “avail themselves of the strictures of BICE” will be allowed to accept varying compensation from third-parties including commissions, 12b-1 fees and revenue-sharing payments.

It’s important to note that BICE is one of several exceptions built into a larger regulatory package, all of which are scheduled to complete their phased implementation period in 2018, although additional delays are possible. 

“Everything You Wanted to Know About BICE But Were Afraid to Ask,” can be found at ifebp.org.

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