The Markets July 13, 2015

Active Management Important to Investors

Professional U.S. investors say protecting capital in down markets is one of the most important considerations when selecting an active manager.
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Sixty-three percent of professional U.S. investors foresee an increase in market volatility in the next 12 months, according to the MFS Active Management Sentiment survey.

Seventy percent say protecting capital in down markets is one of the most important considerations when selecting an active manager, and 63% say actively managed strategies work best in a falling market. Evidence bears this out, MFS Investment Management says; over the past 25 years, the top quartile of active managers have achieved an average of 7.6% in excess returns in bear markets.

Despite significant flows to passive strategies since the financial crisis of 2008, only 38% of professional investors are highly confident in passive management.

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When selecting an active manager, 83% of investors in the U.S. say risk management is the most important trait, followed by active security selection (67%). Asked about their concerns regarding active managers, 68% of respondents said being too focused on short-term investment returns of the past 12 months or less. In the U.S., 82% of investors said they are willing to pay more for outperformance over five years, and 68% are willing to pay more for managers who can outperform over 10 years.

Sixty percent of U.S. professional investors said that actively managed strategies will continue to play a significant role in their portfolios in the future, and U.S. investors have allocated 77% of their portfolio assets to active investment strategies.

“At some point, we will see additional volatility, and that creates opportunity for active managers to identify risks and generate alpha,” says Joe Flaherty, chief investment risk officer for MFS Investment Management. “Downside risk management is part of the value proposition that active managers can deliver through research and security selection. Many active global managers have significantly outperformed in falling markets. A passive strategy, by definition, takes full market risk. In recent years, strategies that straddle the line between active and passive have become increasingly popular with investors.”

CoreData conducted the study for MFS Investment Management, based on a survey 1,038 financial advisers, institutional investors and professional buyers around the globe, including 575 in the United States.

Compliance July 13, 2015

On Remand, ABB Wins Fund Change Case

In the long-running Tussey v. ABB lawsuit, a court found ABB breached its fiduciary duties, but a procedural error by plaintiffs handed ABB the win.
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On remand, a district court weighing whether fiduciaries to a 401(k) plan abused their discretion when making an investment lineup change found they did, but since plaintiffs in the case failed to prove damages using the appropriate calculation, judgement was entered in favor of the fiduciaries.

The decision was made in the long-running case Tussey v. ABB in the 8th Circuit. The 8th U.S. Circuit Court of Appeals ruled that the district court’s opinion concerning the ABB PRISM plan’s switch from the Vanguard Wellington fund to the Fidelity Freedom target-date funds shows clear signs of hindsight influence regarding the market for target-date funds at the time of the redesign and the investment options’ subsequent performance. The court added that it could not be certain that the district court would have come to the same conclusion had it used the correct standard of deference to the fiduciaries in deciding whether the change was appropriate in relation to plan and investment policy statement (IPS) terms. The appellate court vacated the district court’s judgment and damages award and remanded for further consideration using the abuse of discretion standard set forth in Firestone Tire & Rubber Co. v. Bruch. 

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The U.S. District Court for the Western District of Missouri noted several procedural irregularities in the decision to switch funds, including:

  • the strong performance of the Wellington Fund during the time period specifically identified in the IPS;
  • ABB’s inconsistent explanations for removing the Wellington Fund and mapping its assets to the Freedom Funds;
  • the fact that ABB took a substantial part of the PRISM plan’s assets and put them into an investment that was so new that ABB needed to make an exception to the IPS; and
  • Fidelity’s explicit offer to give ABB a better deal if the Wellington assets were mapped into the Freedom Funds.

 

Given these irregularities, “the Court is confident that ABB was conflicted when it chose to take the Wellington Fund assets and put them into the Fidelity Freedom Funds,” the district court's opinion says. “The Court believes that the ABB Defendants knew that removing the Wellington Fund and mapping its assets to the Freedom Funds would result in persistent increased revenues to Fidelity, which ultimately would benefit ABB.” 

According to the court opinion, as a result of the fund switch, the PRISM plan sustained a loss because the Wellington Fund consistently outperformed the Freedom Funds after the mapping occurred. 

However, the district court said the plaintiffs in the case failed to satisfy their burden of proof on the issue of damages. The 8th Circuit noted that the district court previously awarded damages in the amount participants who had invested in the Wellington fund would have had if ABB had not switched funds and the participants had remained in the Wellington fund for the entire period at issue. The appellate court determined that, in light of the IPS requirement to add a managed allocation fund, the damages would more accurately be measure by comparing the difference of the Freedom Funds and the minimum return of the subset of managed funds the ABB fiduciaries could have chosen. 

Prior to making a decision, the district court had given both sides of the case an opportunity to make a new argument for damages, but they did not. The plaintiffs contended the 8th Circuit was wrong. They argued that the proper measure of damages would be the prudent alternative that provides the largest damages unless the breaching fiduciary sustains its burden of proof to establish a lower award is justified. However, the court noted they did not present what that figure would be.

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