Monday, April 09, 2018

Passive investors to benefit from Active Share metric disclosures

By R. Jason Howard, J.D.

New York Attorney General Eric T. Schneiderman has released a report on mutual fund fees and announced agreements by 13 major firms to make new and enhanced disclosures to retail investors following an industry-wide investigation. Under the agreements, “the firms will disclose new information that can help retail investors determine whether a higher-cost, actively managed mutual fund fits their investment goals better than another, lower-cost alternative.”

Active Share. Active Share, as the newly disclosed information is known, “measures the percentage of stock holdings in a fund’s portfolio that differs from that fund’s benchmark index—key information investors can use to determine whether a higher-fee, actively managed fund has the potential to beat the benchmark returns of a lower-cost, passively managed fund.”

The Attorney General said, “These new disclosures will give Main Street investors access to critical information before making investment decisions for themselves and their families. By working with us to help level the playing field for all investors, these firms are taking an important step forward. I encourage all mutual fund firms to follow suit.”

The report. The April 2018 Mutual Fund Fees and Active Shares report detailed some of the key findings from the industry-wide investigation, including:
  • Actively managed funds are typically much more expensive investment options than index funds. On average, fees on an investment in an actively managed fund cost an investor almost 4.5 times more per year than fees on an investment in a passive fund. 
  • Higher fees for actively managed mutual funds do not necessarily reflect a higher level of active management. When choosing among actively managed mutual funds, investors should not conclude that a higher fee necessarily reflects a higher level of active management, as measured by the fund’s variation from its benchmark. Based on a review of fees and disclosures for over 2,000 mutual funds, investors cannot necessarily assume that a high fee, or expense ratio, for a particular mutual fund means that the fund will have a high Active Share—in other words, an investor cannot look only to the fees charged to invest in a fund in order to assess the fund’s potential to outperform the market (or the risk of underperformance), as measured by the Active Share metric. 
  • Fund managers use Active Share information to help analyze mutual fund investments, and mutual fund companies provide Active Share to some professional and institutional investors, but generally not to retail investors. The Active Share metric allows investors to understand how much a particular fund overlaps with or diverges from its benchmark index. While not an absolute indicator of active management, Active Share has become a widely-used metric for mutual fund managers. 
The report also stresses the importance of investor vigilance in an era where the “Trump administration and Congress have taken steps to roll back federal regulations that protect investors when they make retirement investment decisions, like choosing to invest in actively management mutual funds.”

Because of the recent changes to fiduciary rules and questions surrounding the standard of care that brokers and financial investors owe to retirement investors under federal law, the report concludes that “Americans saving for retirement must be especially vigilant in evaluating investment choices and the investment recommendations made by their advisors.”

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