401k Actively Managed Funds: Choosing the Right Strategy

Choosing the right 401k actively managed fund can be a daunting task, but understanding the basics can help you make a more informed decision.

Actively managed funds are designed to beat the market by actively buying and selling securities, but research shows that only about 4% of actively managed funds outperform their benchmarks over the long term.

To increase your chances of success, it's essential to consider your investment goals and risk tolerance. As we discussed earlier, a fund's investment style and strategy can greatly impact its performance.

Some funds may focus on growth, while others may prioritize income or capital preservation.

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Passively managed funds track a market index with the goal of replicating its performance with minimum management and lower fees.

The most common index funds in 401(k) plans are cap-weighted index funds that track well-known market indexes like the S&P 500 or the Russell 2000.

Active management is when a professional portfolio manager selects securities with the goal of outperforming the index or providing additional risk protection.

Skilled fund managers have outperformed their indexes benchmarks, especially in less efficient markets such as emerging markets or small cap.

To select an active investment manager, review their performance track record and focus on consistency, risk-adjusted returns, and benchmark comparisons.

Reviewing investment fees is also critical, as active managers generally have higher fees than indexes, but the fees should be reasonable compared to other active managers in their peer group.

While historical returns and fees are important, they are not a guarantee of future results.

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Active management can offer additional diversification when compared to large cap weighted indexes, which can lead to concentration in specific sectors or stocks.

Actively managed funds are not bound by the same weightings as index funds, allowing them to diversify their investments and reduce risk.

Active managers can adjust their funds in response to market conditions, protecting assets during market downturns.

This flexibility can help protect against losses during market downturns, making active management a valuable tool for 401(k) plan sponsors.

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Skilled fund managers have outperformed their indexes benchmarks, especially in less efficient markets such as emerging markets or small cap.

Active managers can focus on specific stocks with countries or sectors with the strongest fundamentals and avoid regions or industries with heightened risks.

One of the most important advantages of active management is the ability to protect assets during market downturns, a crucial consideration for 401(k) plan sponsors.

Recent research suggests that active management is unlikely to produce returns that beat passive index investing, but this doesn't mean active management has no value.

Active management can provide additional risk protection, which is especially important during market downturns.

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Active management strategies can be quite complex, but I'll break it down for you.

Passive index funds track a market index with the goal of replicating its performance with minimum management and lower fees.

Active managers, on the other hand, select securities with the goal of outperforming the index or providing additional risk protection. They develop an investment strategy using market research and analysis and use security selection, market timing, and risk management to try to improve performance outcomes.

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Research suggests that active management is unlikely to produce returns that beat passive index investing, especially in more efficient markets.

However, in less efficient markets such as emerging markets or small cap, skilled fund managers have outperformed their indexes benchmarks. Within these markets, there are different political and governance risks, unique growth trajectories, and limited coverage of the companies included in the index.

Active managers can focus on specific stocks with counties or sectors with the strongest fundamentals and avoid regions or industries with heightened risks.

Passive management is all about tracking a market index with the goal of replicating its performance with minimum management and lower fees. This strategy is often used in 401(k) plans, where the most common index funds track well-known market indexes like the S&P 500 or the Russell 2000.

Passive funds are typically offered at lower expense ratios compared to actively managed funds because they require less research and active decision-making. This is because passive funds simply invest in the same securities as the index, without trying to outperform it.

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Active management, on the other hand, involves a professional portfolio manager selecting securities with the goal of outperforming the index or providing additional risk protection. This strategy requires more research and analysis, and can be more expensive due to the need for active decision-making.

Research suggests that active management is unlikely to produce returns that beat passive index investing. A study looked at the composition of target date funds in 401(k)s and found that passive indexes with modest fees deducted outperformed active management using various methods of choosing active managers.

The results of this study are clear: active management did not add value over the time frame studied. In fact, the estimated retirement savings using passive management were significantly higher than those using active management.

Here's a comparison of the estimated retirement savings using different active management strategies versus passive management:

It's worth noting that skilled fund managers have outperformed their indexes benchmarks in certain markets, such as emerging markets or small cap. However, these markets are often less efficient and come with unique risks.

Including actives in your plan can provide additional diversification, especially when compared to large cap weighted indexes. Index funds are heavily weighted toward the largest companies in the benchmark, which can lead to concentration in specific sectors or stocks.

Active management can offer flexibility in responding to market conditions, helping to protect assets during market downturns. This is because active managers can adjust their funds in response to market conditions, unlike index funds which remain fully invested in their cap weighted benchmark.

Actively managed funds may have higher fees than passive counterparts, but sometimes the active management results in outperformance. This can lead to higher potential returns, which can be a goal of some plan participants with higher risk tolerance.

Many active fund managers do a good job defending against or recovering from downturns, often with a slightly more conservative blend of investments or the ability to strategically add undervalued assets during down markets.

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Including both active and passive management in your 401(k) plan can provide participants with the tools they need to build a diversified lineup. Actively managed funds can provide value to a plan through risk mitigation, diversification, and potential outperformance.

To get the most out of actively managed funds, you should review the manager's performance track record, focusing on consistency, risk-adjusted returns, and benchmark comparisons.

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There's no one-size-fits-all answer when it comes to retirement plan investment menus. ERISA doesn't mandate selecting the lowest cost funds, but rather encourages a reasoned evaluation of a fund's offerings and fees compared to its performance and value for participants.

Fiduciaries should consider a fund's performance and value when making investment decisions. This means looking beyond just the cost of a fund to determine if it's the right choice for participants.

Ultimately, the goal is to provide a wide array of choice, performance, and risk characteristics in a retirement plan investment menu. This requires careful consideration and evaluation to ensure that participants have access to high-quality investment options.

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