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As fees fall, actively managed funds suffer

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The era of fee compression has not been kind to actively managed funds.

Active products have less inflows than passive peers, according to Morningstar’s 2018 fund fee study. The lowest-priced 20% of funds had net inflows of $605 billion in assets — and only 26% of those funds were active, according to the report.

“The wind is not blowing for active management,” says Ben Johnson, director of passive funds research at Morningstar.

Most actively-managed funds underperform. Only 17.6% of large-cap funds had better returns than the S&P 500 at the end of 2018, according to S&P's latest SPIVA report which tracks the performance of active funds versus the performance of their benchmarks. Price is also a factor. Active fund investors are paying about 4.5 times more than passive-fund investors on each dollar, according to the study. This is the widest disparity since 2000.

The average expense ratio among the top-performers is 40 basis points higher than the average.
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As a result, asset managers are seeking alternatives to standard mutual fund products, according to Johnson. “They’re looking for new formats that they can package and deliver their strategies in,” he says.

Some of these new formats include strategic beta ETFs, which are growing faster than the average passive fund.

The SEC has also signaled it may approve the first non-transparent ETF, which would allow asset managers to package their active strategies in a passive product without disclosing their secret sauce.

“I think it solves a problem more faced by asset managers than it does investors.” Johnson says, noting that there are few fully-transparent active ETFs that have been successful. “There aren’t many investors who are clamoring for them,” he says.

Some fund companies are contemplating pricing models tied to performance.

Others don’t think that the existing ETF structure is clear enough for clients as it stands today. “Even ETFs that are transparent, you need tools to see what’s in there,” says Joshua Levin, co-founder of ESG investing startup OpenInvest.

Some fund companies are contemplating alternative pricing models tied to performance. One case in point is Peter Kraus, former CEO of AllianceBernstein, and his new venture, Aperture Investors, which ties the fund’s compensation with five-year performance.

“Practically speaking, it’s difficult to say whether that leaves investors any better off than if the manager were just to cut to the chase and cut fees which is the last thing many want to do,” Johnson says.

Other fund companies, such as Primecap Management Company, have closed funds from new investors, a move which could help preserve a higher price tag, according to Lori Zager of 2X Wealth Group, a team at Ingalls & Snyder, who notes that several emerging market funds she has been interested in have been closed. “Some of the best ones are hard to get into,” she says.

Alternatively, other fund companies are “just getting paid less,” says Zager’s partner, Lisa James.

Either way, there’s still room for mutual funds in the marketplace.

“If you can get managers that outperform, it’s worth the fees,” Zager says.

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