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Dalbar: Active or Passive Funds? 12 Factors to Consider (Beyond Fees)

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As investors pile into index-based funds to chase lower fees, one fund research group is sharing its view on what that choice means for investors over time, and the results should surprise both advisors and their clients.

In the longer term, Dalbar says, active investments have produced better results, which reflects investors’ tendency to stay in these funds for longer periods of time.

Over short-term horizons, though, passive investments do better—such as when they are driven by run-ups in the market following election results and other factors.

In looking at how and why active investments post superior investment statistics to passive funds, the Dalbar team points to stronger investor retention during market downturns, asset allocation and capital preservation strategies of active investments as being advantageous.

“The accolades for passive investments have been deaf to best interests of investors,” said Dalbar CEO Lou Harvey. “We uncovered 12 important factors beyond expenses that should be considered.”

Dalbar’s report concludes that investors and advisors should choose active or passive funds by looking closely at investors’ “needs and preferences,” as well as examining carefully the associated costs of asset allocation and capital preservation strategies not available in passive funds.

Time Trap

The annualized performance difference for active funds vs. passive funds over the 15-year period ending Dec. 31 is 1.2%, according to Dalbar research.

This spread drops to 0% for a 10-year annualized average, but stands at 0.4% over a 5-year time horizon.

In shorter periods, like the 3-year range, passive funds top active by 1.7%. They also outperform on a 1-year basis at an annualized rate of 2.7%.

The group’s study emphasizes the “unregulated and unaccountable nature” of the indexes tracked by passive funds.

It also highlights the relative “closeness” of the different performance results of active and passive funds, which suggests that investors and advisors should look beyond investment characteristics and “always include situational factors applicable” to individual investors. 

The following 12 features should be considered (along with costs) when picking active and passive funds, according to Dalbar:

  1. Design objective
  2. Role of investment manager
  3. Investment selection
  4. Investment return objective
  5. Changes to fund portfolio composition
  6. Diversification
  7. Asset allocation
  8. Other capital preservation
  9. Regulation of investment decisions
  10. Performance measurement
  11. Vulnerability to imprudent action
  12. Down-market retention

Dalbar ends its analysis by looking at the “temptation” of passive funds, which are based in indexes that get coverage “every second on television or Internet-based services, every day in newscasts and when news magazines are published.”

This barrage of information invariably “creates concern for one investor or another,” the research group says. As a result, we see “imprudent investing in response to excessive exuberance in the news and untimely cashing out when claims of catastrophes are made.”

Such moves often result in investors “buying at market highs and selling at low points,” leading to “a significant loss of return for the average investor.”

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