Home ListingDecember 10, 2015

For Plan Sponsors, Passive Doesn’t Equal Safe

Plan sponsors have significant fiduciary obligations regardless of whether they choose active or passive management, according to Russell Investments.

Reported by Featured Author

Fiduciary responsibilities don’t end when plan sponsors go passive.

In a new research note from Russell Investments, Product Manager Kevin Knowles and Managing Director Josh Cohen argued against the premise that fiduciary obligations are nearly eliminated when defined contribution (DC) plan sponsors adopt a passive investing approach.

Instead, Cohen and Knowles wrote that every decision made by fiduciaries and their managers is “an active decision that has implications and requires prudent review, even if implemented through passive investment vehicles.”

While there are “certainly some areas that will require less monitoring relative to an active fund,” they continued, the fiduciary burden and due diligence requirements of passive investments are still significant—including monitoring requirements that are unique to passive management.

The Russell report cited five key areas to review: the index provider’s organization and methodology, the investment manager’s implementation capabilities, the investment manager’s fee structure, the lack of exposure to asset classes that are expensive to implement passively, and, in the case of target date funds, the fund’s glide path and underlying asset allocation.

For example, DC plan sponsors need to know where the index data behind a fund are coming from. Fund managers sometimes change index providers, and those changes can easily go unnoticed, especially if the fund name is generic and does not need to change reflect the new underlying index.

“As a plan sponsor, you should be asking critical questions of your manager when such changes are made,” argued Cohen and Knowles.

Additionally, fiduciaries need to evaluate the exposures offered by their chosen index funds. The report cited the example of China A shares, which appeared in FTSE Russell’s global, international, and emerging market indexes, but not those of MSCI.

The choice between active and passive management is itself a fiduciary responsibility, Knowles and Cohen pointed out. Less efficient markets such as US small cap equities offer a higher probability active managers outperforming.

They wrote that even if it may “seem ‘safer’ to pick a particular index option, if you are decided on a passive option in an asset class where active management tends to provide strong outperformance opportunities, and if you can access such active management cost-effectively, you have a fiduciary obligation to consider that for your participants.”

Plan sponsors, Knowles and Cohen concluded, are responsible for the selection and monitoring of any manager, whether active, passive, or a combination of the two.

“Don’t fall into the trap of thinking all-passive management is the ‘safe fiduciary option,’” they warned.