401(K) presentation - are actively managed funds appropriate?

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happysteward
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401(K) presentation - are actively managed funds appropriate?

Post by happysteward » Wed May 15, 2019 6:45 am

Hello boglehead friends,

As a fiduciary on my company 401(k) I am uncomfortable with our menu offering active fund choices. I do not think this is in our employees best interest. Below is my justification to at least start the discussion. The justification is one question and three points. Would love some input from you before I go before our committee, thanks !


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UPDATE/response
Thanks to all for the posts...I am still looking for substantive reasons to include actively managed funds...there may be "people who prefer" these funds in my company...active funds may not "be that bad performance wise"..."not all active funds are high expense"...but as someone responsible these are not helpful in the light of data...

I am trying to drill down to data, rather than emotion, and the data seems clear...below is M* data comparing actively managed funds to their INVESTABLE passive funds grouped as a cohort...this is even better than the SPIVA data I cite above which compares active funds against their chosen UNINVESTABLE passive index. Both tell a similar story, even the "low cost" active funds have performance issues as the M* data shows...

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Last edited by happysteward on Mon May 20, 2019 7:04 am, edited 1 time in total.
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dbr
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by dbr » Wed May 15, 2019 7:36 am

You realize that many low cost funds in appropriate investments are not index funds, such as all Vanguard US Treasury Funds and such stalwarts as Wellington and Wellesley. I would not be too quick to just propose that all offerings have to be made in index funds. It might be the better fiduciary decision is to select funds on cost rather than management method. Cost data is reported and on the books, while fund performance cannot be reliably assessed. Don't forget not all fund costs and income are in the ER.

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jeffyscott
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by jeffyscott » Wed May 15, 2019 8:19 am

Agree with above and in addition:

I think looking at one arbitrary 10 year period is an inadequate analysis. If you start from around the market high in fall 2007, DDFIX is ahead of your proposed substitute, VVIAX and it declined much less in 2008-09. It's also ahead of VVIAX from date of inception.

From reading the M* report, it appears to be dividend growth fund and I would compare it to Vanguard Dividend Appreciation Index (VDADX), not a value index.

For RAFGX vs. VIGAX, if you move the start date of the comparison back to the high in fall 2008 there doesn't appear to be much difference in performance.
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vineviz
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by vineviz » Wed May 15, 2019 8:30 am

happysteward wrote:
Wed May 15, 2019 6:45 am
Hello boglehead friends,

As a fiduciary on my company 401(k) I am uncomfortable with our menu offering active fund choices. I do not think this is in our employees best interest. Below is my justification to at least start the discussion. The justification is one question and three points. Would love some input from you before I go before our committee, thanks !
I can’t imagine a plan fiduciary signing off on a a menu of investment options that include NO actively managed funds. Even the most progressive sponsors will (and IMHO should) offer at least one active fund in each major investment category.

No matter what we think many investors greatly prefer active funds, and the 401k options should accommodate them too.

Obviously due diligence should be exercised to ensure those active funds are best-in-class (good processes, relatively low fees, stable management, etc.). And the default options)eg target date funds) should probably be low-cost index offerings.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Nate79
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by Nate79 » Wed May 15, 2019 8:32 am

Does your 401k offer low cost index funds in addition to active funds? If so then I would be happy and move on. If your 401k only offers high expense funds (active or index) then you have some concern but focusing only on "active" is wrong. In fact that you even suggest fighting only against active funds in my opinion means maybe you are not capable of being a fiduciary for a 401k plan.

My 401k for example offers both index and active funds where there are very low cost options that I can choose. However, I choose to use the active international fund vs the index as the fees for the active fund are low (<0.5%) and the performance has been good. I'm ok with that decision and do not consider it appropriate for the 401k committee to force me into index funds.

dot00
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by dot00 » Wed May 15, 2019 11:48 am

Agree with the above as well.

The important points as fiduciaries in this role are to ensure costs are reasonable, proper due diligence on and ongoing monitoring of actively managed funds occurs, and that plan participants have a reasonable level of choices. I am on a retirement plan committee now and have been on a committee at another employer in the past. In my experience, the bulk of effort is ensuring that actively managed funds are performing “well” relative to peers and behaving as advertised, ie small cap growth fund doesn’t suddenly shift into large cap value. It can get a little wonky talking about style drift, information ratios, etc. but I enjoy this level of discussion. Can’t always say the same for my fiduciary peers.

A lot of effort also goes into evaluating TDFs based on composition (funds, asset allocation) and glide paths. Plan demographics play an important role here.

All that said, the important thing is to set aside your own personal beliefs and do what is best for your plan participants as a whole. Some will want active funds. Some will use only index funds. Some will put $ into every fund in the plan because they can’t figure it out or can’t choose. In my own experience we were mindful of the number of funds available in each category (Morningstar). So only one small cap value, large growth, etc. The paradox of choice is illustrated very clearly in looking at plan participant behavior...

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Re: 401(K) presentation - are actively managed funds appropriate?

Post by HEDGEFUNDIE » Wed May 15, 2019 12:53 pm

OP, which would you rather have:

(1) a menu of only index funds, and as a result a substantial number of employees forgoing 401k contributions altogether so they can invest in the active funds that they believe will outperform, incurring high costs and maybe even advisor fees, or

(2) a menu of index funds and low cost active funds (<0.5 ER) that boosts 401k participation

As a fiduciary your choice should be clear.

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Re: 401(K) presentation - are actively managed funds appropriate?

Post by XdUzHa3NtSeIkBkIGPVn » Wed May 15, 2019 1:36 pm

People posting here want an active fund because of very subtle reasons (e.g. "they're high-quality, but low-cost, and I prefer them for specific investment types"). That means you're probably a sophisticated investor, more knowledgeable than 99 out of 100 typical 401k investors out there.

I think the amount of choices is a much bigger barrier not only for the vast majority of investors, but for the would-be investors that simply don't participate in the 401k because of the overwhelming amount of choices. If I was a fiduciary trying to improve the investment results of all of them (not just Bogleheads that want to invest in actively-managed international small-value after a careful Monte Carlo analysis), I would radically reduce choices:
  • Indexed Total Market.
  • Indexed Total International.
  • Either an Aggregate Bond fund or a stable value fund.
It would make the lives of that 99% much easier, encourage those on the fence to invest, and, yes, annoy sophisticated investors (including me) who want more choice. Those sophisticated investors "forced" into index funds will be fine, though. And if you added a brokerage window they'd be happy, too.

PS: HEDGEFUNDIE, you should hang out with non-sophisticated investors if you think people will flat-out refuse to use a 401k without their favorite active funds.

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vineviz
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by vineviz » Wed May 15, 2019 1:45 pm

XdUzHa3NtSeIkBkIGPVn wrote:
Wed May 15, 2019 1:36 pm
People posting here want an active fund because of very subtle reasons (e.g. "they're high-quality, but low-cost, and I prefer them for specific investment types"). That means you're probably a sophisticated investor, more knowledgeable than 99 out of 100 typical 401k investors out there.

I think the amount of choices is a much bigger barrier not only for the vast majority of investors, but for the would-be investors that simply don't participate in the 401k because of the overwhelming amount of choices. If I was a fiduciary trying to improve the investment results of all of them (not just Bogleheads that want to invest in actively-managed international small-value after a careful Monte Carlo analysis), I would radically reduce choices:
  • Indexed Total Market.
  • Indexed Total International.
  • Either an Aggregate Bond fund or a stable value fund.
It would make the lives of that 99% much easier, encourage those on the fence to invest, and, yes, annoy sophisticated investors (including me) who want more choice. Those sophisticated investors "forced" into index funds will be fine, though. And if you added a brokerage window they'd be happy, too.

PS: HEDGEFUNDIE, you should hang out with non-sophisticated investors if you think people will flat-out refuse to use a 401k when they don't see active funds in there.
If you were on the investment committee for a plan , I expect you’d receive enough training to understand why a plan with only those three choices would likely violate the plan’s fiduciary obligations.

Engineering a good plan isn’t rocket science but it it’s not a walk in the park either. Limiting the number of funds is great to a point, but a plan can have too few choices as well as too many. The best plans I’ve seen generally include between 8 and 16 funds (counting all the target date funds as one).
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

HEDGEFUNDIE
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by HEDGEFUNDIE » Wed May 15, 2019 1:51 pm

XdUzHa3NtSeIkBkIGPVn wrote:
Wed May 15, 2019 1:36 pm
PS: HEDGEFUNDIE, you should hang out with non-sophisticated investors if you think people will flat-out refuse to use a 401k without their favorite active funds.
The stages of financial sophistication are:

1. Investing in individual stocks
2. Investing in active managers
3. Investing in index funds

There’s a reason Jack Bogle had to invent the index fund. What do you think the investment landscape looked like before then?

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Reb Tevye
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by Reb Tevye » Wed May 15, 2019 3:13 pm

happysteward wrote:
Wed May 15, 2019 6:45 am
As a fiduciary on my company 401(k) I am uncomfortable with our menu offering active fund choices. I do not think this is in our employees best interest.
The Cheetos in the vending machine are also probably not in their best interest. Now, THAT would be a contentious employee committee.

I’ve seen your concern addressed a couple ways:
A) An opt-in linked 401k brokerage account that allows intrepid participants to invest in nearly any fund or stock or bond on offer, Eg at Fidelity. Then the plan choices can be more vanilla.
B) Or organize and present the offerings in a certain way. Eg
- “Target Date Funds” - Hey are you 32 years old and not money savvy, use this one fund and you won’t need to fuss.
- 6 or so “Core funds”, like Total US Stock, Total Int’l Stock, Total Bond, Money market, Short Term Bond, Stable Value
- “Additional Funds” Palooza of active and other indexes of factors, sub-markets, etc.
"So, what would have been so terrible if I had a small fortune?"

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Kenkat
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by Kenkat » Wed May 15, 2019 3:27 pm

I think the most reasonable approach would be to offer a mix of index funds and low cost active funds across all of the major asset classes. There could really be no questions as to suitability from anyone under that approach.

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XdUzHa3NtSeIkBkIGPVn
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by XdUzHa3NtSeIkBkIGPVn » Thu May 16, 2019 2:18 pm

vineviz wrote:
Wed May 15, 2019 1:45 pm
[...]
If you were on the investment committee for a plan , I expect you’d receive enough training to understand why a plan with only those three choices would likely violate the plan’s fiduciary obligations.
Can you be more specific? I am familiar with fiduciary obligations (here's a page with more info), and "lots of choices" is not mentioned as a requirement.
vineviz wrote:
Wed May 15, 2019 1:45 pm
Engineering a good plan isn’t rocket science but it it’s not a walk in the park either. Limiting the number of funds is great to a point, but a plan can have too few choices as well as too many. The best plans I’ve seen generally include between 8 and 16 funds (counting all the target date funds as one).
Good point with regards to target date funds. Still, those are usually a combination of index funds in different proportions, not active funds. Counting those, that's 3 plus maybe 8 target date funds. Why do you need to add active funds at all?

The federal government created the TSP for federal employees, and outside of target funds, there's essentially 5 funds, all passive (one buys treasuries without an index). Are they not fulfilling their fiduciary obligations?
HEDGEFUNDIE wrote:
Wed May 15, 2019 1:51 pm
XdUzHa3NtSeIkBkIGPVn wrote:
Wed May 15, 2019 1:36 pm
PS: HEDGEFUNDIE, you should hang out with non-sophisticated investors if you think people will flat-out refuse to use a 401k without their favorite active funds.
The stages of financial sophistication are:

1. Investing in individual stocks
2. Investing in active managers
3. Investing in index funds

There’s a reason Jack Bogle had to invent the index fund. What do you think the investment landscape looked like before then?
I question #2 there. The vast majority of people don't invest in active funds because they believe they're better than index funds. They invest in them because:
  • A salesperson made it seem like the best choice.
  • They don't know about index funds.
  • They're available to them in a 401k, sometimes as the only option.
I agree that the investment landscape before index funds was bad. And just like then, a lot of current active funds are high cost, and have performance distorted by survivor bias. That's more reason not to include them in a menu designed for those who aren't sophisticated investors, no?

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vineviz
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by vineviz » Thu May 16, 2019 2:31 pm

XdUzHa3NtSeIkBkIGPVn wrote:
Thu May 16, 2019 2:18 pm
Good point with regards to target date funds. Still, those are usually a combination of index funds in different proportions, not active funds.
Not necessarily. There are more than a few TDF series that mostly (or even entirely) consist of actively managed funds.
XdUzHa3NtSeIkBkIGPVn wrote:
Thu May 16, 2019 2:18 pm
Counting those, that's 3 plus maybe 8 target date funds. Why do you need to add active funds at all?


I think this was well covered in prior replies.
XdUzHa3NtSeIkBkIGPVn wrote:
Thu May 16, 2019 2:18 pm
The federal government created the TSP for federal employees, and outside of target funds, there's essentially 5 funds, all passive (one buys treasuries without an index). Are they not fulfilling their fiduciary obligations?
The TSP isn't subject to the same laws (e.g. ERISA) that govern private-sector plans. In short, the federal government has no fiduciary duty with respect to TSP investors.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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XdUzHa3NtSeIkBkIGPVn
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by XdUzHa3NtSeIkBkIGPVn » Thu May 16, 2019 3:20 pm

vineviz wrote:
Thu May 16, 2019 2:31 pm
XdUzHa3NtSeIkBkIGPVn wrote:
Thu May 16, 2019 2:18 pm
Counting those, that's 3 plus maybe 8 target date funds. Why do you need to add active funds at all?
I think this was well covered in prior replies.
So far I've heard no substantive arguments. The posts in favor essentially said "I like them", "I can't imagine a plan without them", and "some active funds are low-cost".

Even when people knowingly prefer them over index funds (a position that is probably very rare), that doesn't make them suitable. I knowingly prefer many types of investments (e.g. precious metals as a <10% position for diversification), that doesn't mean they would be a good idea in a 401k menu.
vineviz wrote:
Thu May 16, 2019 2:31 pm
XdUzHa3NtSeIkBkIGPVn wrote:
Thu May 16, 2019 2:18 pm
The federal government created the TSP for federal employees, and outside of target funds, there's essentially 5 funds, all passive (one buys treasuries without an index). Are they not fulfilling their fiduciary obligations?
The TSP isn't subject to the same laws (e.g. ERISA) that govern private-sector plans. In short, the federal government has no fiduciary duty with respect to TSP investors.
That sidesteps the question though. What makes the TSP funds (or a set of similar index funds) an inappropriate selection for a retirement plan?

If maximum investor choice was the main goal, don't just add 8 active funds and call it a day. A far better solution would be a brokerage window where you can buy anything you fancy in the open market (after signing a disclosure saying you understand the risks and all).

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happysteward
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Re: 401(K) presentation - are actively managed funds appropriate?

Post by happysteward » Mon May 20, 2019 7:03 am

Thanks to all for the posts...I am still looking for substantive reasons to include actively managed funds...there may be "people who prefer" these funds in my company...active funds may not "be that bad performance wise"..."not all active funds are high expense"...but as someone responsible these are not helpful in the light of data...

I am trying to drill down to data, rather than emotion, and the data seems clear...below is M* data comparing actively managed funds to their INVESTABLE passive funds grouped as a cohort...this is even better than the SPIVA data I cite above which compares active funds against their chosen UNINVESTABLE passive index. Both tell a similar story, even the "low cost" active funds have performance issues as the M* data shows...

Image
"How much money is enough?", John Rockefeller responded, "...just a little bit more." | "He who loves money will not be satisfied with money..." Ecclesiastes 5:10

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