It is not easy for retirement plan sponsors to know what to look for when selecting an actively managed fund, experts say, which is why they highly recommend that sponsors work with a retirement plan adviser or consultant when selecting funds for their investment lineup.
However, there are some basic qualitative and quantitative factors that sponsors should be aware of, as well as certain key points they should ensure are touched on when educating participants about actively managed funds.
Rich Weiss, multi-asset strategies chief investment officer (CIO) at American Century Investments, says assessing and selecting actively managed funds is “very complicated and tricky,” which is why he strongly recommends that sponsors work with professionals to help them with these decisions. “Lay people without the training to do the due diligence typically make the mistake of picking funds that have performed the best in the past three years, which is actually the worst way to pick a fund. That will almost guarantee you the worst returns.”
That said, Weiss adds that he believes sponsors should be aware of the basics of what to look for in actively managed funds.
On the qualitative side, Weiss says the first question a sponsor should ask is how long the investment firm offering the fund has been around. “What is the expertise of its portfolio managers?” Weiss queries. “What is its turnover? What is the track record of the portfolio manager of the specific fund in question?”
Only after asking all these questions should a sponsor then move into the “metrics of active performance,” Weiss says. “This starts with asking, ‘What is the fund’s mandate, benchmark and competitive class in which it sits? How has it done over the past three, five and 10 years, and how is it ranked relative to competitors? Has its performance been consistent over time, or is it a one-hit wonder? How is the fund delivering its returns? Is it through stock picking, sector rotation or market timing?’”
He also notes that Sharpe ratios, which are used to help investors understand the return of an investment compared with its risk, are important as well. He encourages sponsors to ask: “‘What kind of risk is the fund manager taking in order to deliver returns? Are there other funds that take less risk but offer greater returns?’”
Ashley DiMayorca, vice president of product management at PGIM Investments, says another critical quantitative factor is the fund’s expense. “Evaluation of expenses is a big focus in the retirement space,” DiMayorca says. “Sponsors need to keep in mind ERISA [Employee Retirement Income Security Act] guidance on expenses in DC [defined contribution] plans. Fiduciaries are only required to make sure fees are reasonable and to act in plan participants’ best interests.”
That means sponsors must not only consider index funds because they are inexpensive, but they must look at actively managed funds as well, she says. “Only active exposure can provide such important sources of value as increased diversification, alpha and risk mitigation. Especially in a low-growth environment, these benefits are crucial to successful retirement outcome.”
So, when evaluating actively managed funds’ fees, it is critical that sponsors look at what value is being delivered for those fees.
It is also helpful to know if the portfolio manager has skin in the game, i.e., if their own money invested in the fund, and whether or not they are compensated based on the fund’s performance, says Sam Solem, portfolio manager, private wealth, at Intrepid Capital.
As far as how sponsors should educate participants about actively managed funds, Weiss says the best way is to start with participants’ risk tolerance and how their goals, objectives and individual needs should direct that. Similar to his advice for sponsors, Weiss recommends that participants work with a retirement plan adviser or other financial adviser when constructing their portfolios. “Look at your own situation and rely on some of the services out there—a financial planner, a consultant. Given a person’s tolerance for risk, they may not want to seek out the highest-performing fund, and, like my advice for sponsors, participants need to look at far more factors than just how they have done in the past three years.”
DiMayorca says it is important that participants—and especially older participants nearing retirement—be equipped with information about a fund’s objective and exposure to equities.
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