Ups and downs of passive vs. active

Defined contribution investors were selective in how they pursued passive and active investing strategies — adding to passively managed equity and actively managed fixed income while subtracting from actively managed equity and passively managed fixed income.

The results of the latest Pensions & Investments annual survey of DC money managers essentially matches the experiences of some industry members who said fees played a key role in passive equity assets rising in 2015. Low interest rates contributed to more fixed-income assets going to actively managed options, they said.

“Sponsors are implementing more streamlined lineups with a focus on lower-cost options, particularly passive equity,” said Russell Ivinjack, a senior partner at Aon Hewitt Investment Consulting, Chicago.

As for fixed-income investing, “everyone is anticipating a rising interest rate environment,” he said. Sponsors are counting on actively managed investments to outperform passive ones and on actively managed portfolios to provide more diversification than passive ones, he added.

Overall DC assets slipped 1.1% to $5.48 trillion as of year-end 2015; internally managed assets declined 0.9% to $4.79 trillion. P&I measures U.S. institutional, tax-exempt assets as of Dec. 31; 244 defined contribution managers were in the 2015 survey, down from 251 the year earlier.

Among equity categories tracked by P&I, active domestic equity assets fell 3.3% to $1.34 trillion, and assets in active international equity dropped 2.2% to $393 billion. Meanwhile, assets in passive domestic equity rose 3.9% to $1.1 trillion, while passive international equity assets jumped 28.2% to $206.9 billion.

“We definitely see a trend toward passive equity mandates,” said David O'Meara, a New York-based senior investment consultant for Willis Towers Watson PLC. “More clients are tilting toward passive equity in defined contribution and defined benefit plans.”

For DC plans, “increased sensitivity” to fees is motivating a greater use of those strategies, he said.

Although Russell Investments “leans toward” passive strategies for equity investing, the company recommends a mixture of passive and active approaches depending on equity subcategories, said Holly Verdeyen, the firm's Chicago-based director of defined contribution investments. “Don't make decisions just on low fees,” she said.

Still, Ms. Verdeyen forecast greater sponsor interest in passive equity due to “a continuing sensitivity to fees” and a fear of ERISA fiduciary-breach lawsuits.

The hybrid approach of mixing active and passive strategies for equity investing was endorsed by Ronald Cohen, the Boston-based head of DCIO and RIA Sales for Wells Fargo Funds. “Add more passive equity where it makes sense,” said Mr. Cohen, noting large-cap domestic equity is a good candidate for passive investing.

He predicted plan sponsors will “continue to push” for passive equity as well as for all forms of target-date fund options this year.

Target-date growth will continue due to auto enrollment, auto escalation and the popularity of target-date funds as qualified default investment alternatives, said Mr. Ivinjack of Aon Hewitt.

In the P&I survey, assets managed in target-date portfolios rose 11.1% to $902.5 billion last year, of which custom target-date strategies gained 8.1% to $94.8 billion.

For the fixed-income categories, the P&I survey found active domestic fixed-income assets climbed 7.8% to $1.04 trillion, while assets in active global/international fixed income advanced 3.6% to $44.8 billion. Assets in passive domestic fixed income dropped 12.3% to $229.6 billion, and assets in passive global/international fixed income fell 17.6% to $5.2 billion.

“A lot of clients are concerned with the interest rate environment,” said Mr. O'Meara of Willis Towers Watson. Adding actively managed investments “gives managers the opportunity to tactically move the portfolio.” Examples of these actively managed investments include high-yield bonds and emerging markets debt, he said.

Mr. Cohen of Wells Fargo said sponsors relying solely on a passively managed fixed-income fund pegged to the Barclays U.S. Aggregate index will be at risk when interest rates rise because U.S. Treasuries account for about 40% of the index.

As a result, some sponsors are looking at a core-plus fund or a “go anywhere” bond fund that adds actively managed components to their fixed-income portfolios. While core-plus and “go anywhere” strategies are similar because they include actively managed investments such as high-yield bonds or emerging markets debt, “go anywhere” mandates have fewer limits on the amounts of actively managed investments than do core-plus portfolios, he said.

The P&I survey also detected changes in investment vehicles, as DC assets invested through mutual funds slipped, dropping 2.7% to $2.18 trillion. Collective trusts and other pooled/commingled funds posted a 4.7% gain to $1.58 trillion. Separate account AUM was relatively flat at $985.9 billion.

DC industry members said the collective trust trend will continue as sponsors seek greater simplicity in fund management and lower fees.

“We're seeing greater use of collective investment trusts,” said Mr. Ivinjack of Aon Hewitt. “It's part of a trend towards indexing and lower fees. There are lower overhead costs than for '40 Act (mutual) funds.”

The growth of collective investment trusts in DC plans is “one of the big trends in the industry,” added Mr. O'Meara of Willis Towers Watson. Lower fees, easier administration and greater flexibility are reasons “this trend definitely continues.”

Many of the largest DC money managers kept their respective rankings in the current survey compared with 2014:

• Vanguard Group Inc., Malvern, Pa., remained in first place with $736 billion in DC AUM, a 4.3% gain from 2014.

• BlackRock Inc., New York, was second as it traded places with Fidelity Investments, Boston. BlackRock had $608.2 billion in assets at the end of last year, up 4% BlackRocks, Boston. BlackRock had $608.2 billion in assets at the end of last year, up 4% from 2014.

• Fidelity's $606.6 billion AUM represented a decline of 2.2% from year-end 2014.

• TIAA Global Asset Management, New York, held on to fourth place with DC AUM of $409.7 billion, virtually the same as in 2014.

• T. Rowe Price Group Inc., Baltimore, reported a gain of 7.7% to $311.6 billion, which enabled it to remain in fifth place.