From an historical perspective, index funds have outperformed actively managed funds. The goal of an index fund is to closely match the performance of a particular benchmark or market “index” – as closely as possible. An actively managed fund aims to outperform their benchmarks and peer group average.
Strategies for index funds are fairly simple and straightforward, the manager buys all or a representative sample of the securities to match the benchmark. In a managed fund, the investment team employs proprietary research and the expertise of the management team to achieve the desired investment outcomes.
Ralph Haberli of BlackRock is Head of 401k Defined Contribution Distribution and says that indexing is experiencing robust growth:
Well it’s interesting – at BlackRock we have both a very large active business and a very large index business and really have seen both sides of this trend which gives an interesting position – we really have no horse in the race. And certainly we’ve seen a lot of dollars float to the indexing side. Clients certainly like the predictability and the value they get in terms of being lower cost and flexible. It fits very nicely into a 401k plan structure. We think it sits quite comfortably side by side with active strategy but certainly there’s an opportunity for more and more index to come through.
So with all the apparent advantages of indexing, why would sponsors do anything but index funds for their participants? Wouldn’t it be simpler and more efficient to just offer a few index funds as a plan sponsor? That would seem to be the case to the average sponsor, right? Haberli suggests other factors should be considered.
This really gets down to one of the core responsibilities you have as a manager of a plan. And the core question I think everyone should ask themselves, and all good plan sponsors do, is what is the objective of the plan? What are they trying to accomplish? And once you set that objective, you can take the next step and ask what are the vehicles at my disposal to meet that objective? Typically plan sponsors are looking to be efficient, so have fees in the mix, but there’s also other factors they’re looking at in terms of being able to navigate to certain outcomes, and that’s really what starts to lead you towards active or passive. There are certain asset classes where people may have lower confidence that active managers can outperform. There may be areas where you can get very efficient – certain equity asset classes tend to fall in that category. Where in other areas, notably fixed income, there’s more of a view in the marketplace that an active manager can really outperform those benchmarks. Now those are generalizations, there are certainly going to be objectives that would take you towards all active or more of an index skew, but that really comes down to the plan sponsor navigating that. Again, we’re in an interesting position as BlackRock in that we have both vehicles. As we engage with our clients, we’re helping them through that tradeoff and certainly we’ll end up in an active situation in certain situations and passive in others.
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