Extensive data shows that passive management has performed far more than its active counterpart Feet Fit for more than a decade. This has helped induce a mass resource shift from active funds to exchange-traded funds (ETFs) and other passive options, and has led to considerable debate about the future of active management and what role it will play in investment portfolios. For example, how should sponsors of Defined Contribution (DC) plans approach this issue?
A recent monograph from the CFA Institute Research Foundation explored that question, among many others, imported by DC Plan sponsors. The book’s media coverage focuses on the role of actively managed funds in the potential investment lineup of the DC Plan and elicits feedback from some influential investment industry voices. The critique below addresses the authors of the monograph.
Our recent publications, Defined Contribution Plan: Challenges and opportunities for plan sponsors, A very broad-based policy has caused considerable controversy over a small portion of the book. Some critics have misinterpreted our discussion of incorporating actively managed investment options into defined contribution (DC) plan lineups. Much of this controversy was caused by an industry news article that incorrectly stated that we believed that DC sponsors could be sued for hiring active directors.
We didn’t say anything like that.
Let’s be clear: we are active management skeptics. Value-added active managers are difficult to recruit and retain, even when sponsored investment committees are managed by professional support. Some planning sponsors have considered the issue and have chosen to provide a suite of passively managed investment options. On the other hand, many sponsors have actively managed investment options and they have suffered no legal consequences for these decisions.
We do not believe that sponsors who manage with due diligence and choose to offer active investment strategies in their investment lineups are putting themselves at legal risk. We argue that sponsors should not suffer any loss in choosing their investment options. By this we mean that sponsors should carefully weigh the costs associated with selecting an active manager (fees, additional investment risk, participant communication, and investment committee time) and convince themselves through their documented consideration that the benefits outweigh the costs. Any investment option would seem obvious as a motive for choosing.
Nevertheless, we would like to emphasize that this statement is a policy guideline, not a legal standard. What we offer to sponsors is that they start with passive management as a baseline for choosing investment options. Active management is built on deviations from a passive benchmark. If active managers cannot add values, then passive is the preferred position, not the other way around.
This rarely seems to be controversial. We believe that many sponsors will come and go in this position. However, if a sponsor can convince himself through thorough research that the additional fees and risks of an actively managed strategy can best serve the purpose of a portion of their plan participants, the sponsor is reasonable in hiring a manager. There are no serious legal risks involved.
Different sponsors will reach different conclusions about the value of active management across different asset categories and investment strategies. This is why the active vs. passive debate has been going on for 50 years and will not disappear soon.
We invite interested practitioners to read our entire book. It is full of interesting observations and recommendations across the full range of responsibilities of DC Plan sponsors. We hope readers will agree with us on some issues and (probably strongly) disagree with others. This is the nature of research and informed debate.
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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.
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