When it comes to the age-old retirement plan industry debate on whether to invest in actively managed or passively managed funds, “our industry focuses on the spin, as opposed to the facts,” said Rick Fulford, executive vice president and head of PIMCO’s U.S. retirement and defined contribution businesses, speaking at the 2018 PLANADVISER National Conference session, “Top Trends.”
“One and a half years ago, we decided to take a look at this active/passive debate with objectivity, looking at the Morningstar direct universe of stocks and bonds and their institutional share class performance over one, three, five, seven and 10 years,” Fulford said. “Passive wins the equity battle. Only 35% of actively managed equity funds beat their indexes at the five year mark.”
When it comes to bonds, with intermediate, global and high yield bonds being the most popular in defined contribution (DC) plans, 85% of actively managed bonds beat their benchmarks, Fulford said.
The reason for the discrepancy between actively managed equity funds and bond funds, he said, is that “the bond market is unique. It consists of a large contingent of non-economic players, folks with an objective other than risk-adjusted returns,” he said. “These include central banks, which perform quantitative easing, defined benefit pension plans interested in hedging and insurance companies with accounting restrictions. They control $50 trillion in bonds, and with the total U.S. bond market being $100 trillion, they can create dislocations.”
Furthermore, he continued, “managing bonds passively is much more difficult and expensive than managing equities. There is a high turnover in fixed income—40%—because bonds mature.”
PIMCO also looked at the fees of actively managed versus passively managed equity and bond funds and discovered that there is a 60 basis point premium in equities for actively managed funds, versus a 30 basis point premium in bonds.
“Actively managed fixed income has a lot of value to add,” Fulford said. “In equities, there are pockets where alpha can be found and others where there are efficiencies and passive management makes sense.”
With regard to target-date funds (TDFs), flows into passively managed TDFs outpace those of actively managed TDFs by far, primarily because actively managed TDFs typically have fees of 50 to 60 basis points, whereas passively managed TDFs can have fees in the single digits, Fulford said.
Therefore, he said, “I don’t think we will see a resurgence of fully active TDFs but a rise in active/passive TDFs, which have seen significant growth.”
As far as retirement plans helping retirees manage their money, Fulford said that TDFs can play a role in decumulation. But that will be only one solution, he said. “There will be a host of strategies,” he predicted. “We need to make defined contribution plans decumulation vehicles, including investments specifically designed for retirement and getting recordkeepers to permit ad hoc payments. There is a lot more to do.
“There are a lot of reasons why annuities don’t work in defined contribution plans, but the market is starting to move in that direction,” he continued. “A recent Callan survey found that 50% of plan sponsors want to keep retirees in their plan, up from 29% the year before, primarily because sponsors want the scale of more assets. A supply of innovative ideas [on retirement income] will come as a result.”
One solution could be managed accounts, which are offered by more than 50% of retirement plans, he said. “Fifty percent of advisers and retirement plan consultants believe managed accounts provide a better solution than TDFs, but advisers need to lift the hood on managed accounts to look at their glidepaths and level of customization.”
As far as environmental, social and governance (ESG) investing is concerned, “there is a gap between a high demand for ESG among participants versus the supply of ESG funds in DC plans,” Fulford said. “Only 4% of plans have an ESG option.”
There are two main hurdles preventing plans from offering ESG funds, he said. First, the Department of Labor (DOL) issued guidance this year indicating that sponsors might create fiduciary difficulties for themselves by offering such an option, he said. The second is the higher fees associated with ESG funds. PIMCO has incorporated ESG screens into its investment process, which is one way sponsors can find funds that meet this criteria, he said.