A recent white paper discusses five common misconceptions that have resulted in passive investments becoming more prevalent in DC plans during the global pandemic.
In MFS’ “Back to Reality: The Role of Active Management in Defined Contribution Plans,” Jonathan Barry, Head of Client Solutions – Investment Solutions Group, Jessica Sclafani, Defined Contribution Retirement Strategist, and Ravi B. Venkataraman, Global Head of Investment Solutions assert that “while active management has always played an important role in retirement plans, the COVID-19 crisis has added new layers of complexity to the active versus passive debate.” They observe that some trends—such as high debt, low interest rates and deglobalization—already were present, while others—such as telecommuting and social distancing—are new.
They argue that it is necessary to distinguish between passing and long-term trends, and to be able to assess their effects on certain industries. And, they add, “skilled active management will be critical to helping plan sponsors and participants sort through these complex issues.”
Passive investments always outperform active funds
Barry, Sclafani and Venkataraman write that often, a year-by-year analysis shows that only some active managers outperform those that are passive. They argue that measuring the value of active management over a longer period is better, as well as “consistent with the long-term nature of retirement programs.”
“Performance data demonstrate that there are still many active managers with the skill and ability to generate excess returns versus passive alternatives,” they write, and suggest that fiduciaries consider the long run and the plan’s objectives when evaluating active management.
Passive investment options reduce fiduciary risk
Barry, Sclafani and Venkataraman note that “There is no denying that passive investments offer attractive fees,” and state that it is valid for a plan fiduciary to consider the relatively higher fees and varying performance of active managers when they are deciding between active and passive funds for DC investment menus.
They add that while recent litigation concerning fees and the risk of it are valid concerns, they should not be a factor in fiduciary decisions. “Fiduciaries are not tasked with choosing the least expensive funds for plan participants; therefore, doing so does not necessarily offer them protection from fiduciary risk and potential litigation,” they argue.
Participants understand active and passive management concepts
Participants’ mixed understanding of active and passive investments makes a fiduciary’s role even more complex, Barry, Sclafani and Venkataraman posit. They note that a study their firm conducted found that it is erroneous to assume that participants can differentiate between active and passive options. At the same time, they say, plan sponsors are asking participants to make such decisions. They suggest that plan fiduciaries can help participants “by structuring investment menus that are geared to the needs of their plan demographics.”
Future investment returns will be similar to historical returns
Barry, Sclafani and Venkataraman believe that consistent savings behavior, consideration of the short and long-term goals, and strong investment returns are the ingredients for better ensuring positive retirement outcomes for participants. They add that their firm’s recent research indicates that future returns “could be significantly less than in the past,” and that excess returns could help keep participants on track.
Sustainable investing is not aligned with fiduciary responsibility
Barry, Sclafani and Venkataraman note that sustainable investing is animportant topic for plan fiduciaries. They suggest following an integrated approach that considers material risks and opportunities, including sustainability, is consistent with exercising fiduciary duties.