This week on WealthTrack, big shake-ups in the mutual fund
industry. Two veteran Morningstar analysts, Christine Benz and Russ Kinnel,
discuss the massive outflows from bond funds into other investments
and from actively managed funds into passive ones. What do
these shifts mean for portfolio returns? Morningstar's dynamic duo is
next on Consuelo Mack WealthTrack. I began the interview by
asking them to name the biggest unintended consequences of the
huge shift from actively managed to passive funds. -Well, as
we've seen flows come out of active funds into passive
products, what that has necessitated is that some fund managers
are having to sell stuff-- -Right. -to meet the shareholder
redemptions and that can cause them to have to realize
capital gains to sell securities that they might, otherwise, wanna
hang onto. And so, what we're kind of bracing ourselves
for, because we have had a five-year equity market rally
as well, is that we could see funds making bigger
than average distributions this year (a) because they're meeting these
redemptions and, (b), because they simply have big capital gains
on their books. -So, what does that do, Russ, to
the funds' performance themselves if they are basically being forced
to maybe sell securities that they didn't necessarily wanna sell
and make their portfolio smaller? What's the impact on their
performance?-Yeah. If you-- If you get redemptions to a critical
level, say, 20%, 30%, 40% of assets, it can have
a negative effect where the manager has to sell and
maybe have to sell at lower prices than they want.
That hurts performance. People redeem more, and so you have
this negative cycle. Now, there's a positive side if maybe
redemptions are a little lighter or maybe flows are very
mild. It can mean the fund still has enough flexibility
to invest well. Usually, five years into a bare-- bull
market, it's a-- lots of funds are overloaded with assets.
This time, there are still some good active funds out
there that people have still overlooked five years in, and
that's a good part of it. -Do you-- Do you
have a couple that you might wanna mention to us?
-Sure. So, I think there's some re-forgotten funds, funds that
we knew once and have kind of lost interest in.
So, for instance, the Longleaf Partners is a very good,
old-school, deep-value focused strategy. -Was that closed at one point?
-It has been closed. -Right. Is it open now? Longleaf?
-Yeah, it's open. -Okay. -They have-- They have a small-cap
fund that's closed, but the Longleaf Partners Fund is open,
and they're very careful about not taking in too much
money or not taking money when the market looks overheated.
So, they're just a really good, old-school-- -Right. -active manager.
-Should I be looking more closely at my portfolio and
saying, you know, "Where am I gonna get hit by
these capital gains?" -I think you should,-- -Yeah. -and the
nice thing is, is that most fund companies will print
preliminary lists of distributions, so you wanna be on your
guard, especially if you had maybe planned to lighten up
on something anyway. It's probably a good reason to get
in there and do your selling before the fund makes
its distribution rather than wait until afterwards, but I usually
say, "Don't try to get too fancy in terms of
timing these distributions." If you did not wanna sell something
in the first place, a capital gains distribution, provided it's,
say, under 10% of the net asset value, shouldn't be
an impetus to preemptively sell. -All right. So, where do
you two come out in this active versus passive debate?
-You know, I think one thing active managers really can
do better than most passive is they can moderate risk.
You don't-- We always think about performance, but an active
manager can go into more stable stocks. They can build
cash. They can, you know, maybe even have some shorts.
But there's a lot of good things that, if you
look at it on the risk-adjusted side, active managers can
add a lot of value. So, I think more so
than an asset class, I think about lowering risk, but
there are asset classes. For instance, muni bonds is one
where indexing doesn't really work and there are some really
good muni managers. Vanguard's funds are only slightly active, but
they are active. -Uh-huh. -Fidelity is a great muni manager
as well. We really like their funds. -So, you don't
wanna just have an index fund of muni bonds. You
wanna have somebody selecting them. -That's right. You don't want
all of those credit risks just taken blindly. -Right. So,
Christine, are there better asset classes to be in active
versus passive, for instance, and vice versa? -I think when
we run the data on this issue, we tend to
see it ebb and flow, and so at certain points
in time, active management will look very good, other times
less good. I really like your point about life stage,
though, because I do think that, for people who are
retired and certainly in the later retirement, the idea of
using an indexed portfolio, a very skinnied-down list of holdings,
I think, can be really helpful. It gives the person
less oversight. I talk to a lot of seniors who
maybe are looking at a spouse who is not engaged
in investing. The all-index portfolio can enable them to have
a very small list of holdings that the spouse could
more readily come in and get his or her arms
around if need be. So, I do like indexing, particularly,
for people who are maybe in their later retirement years.