IS NOW THE TIME TO CONSIDER ACTIVELY MANAGED FUNDS? Dec. 1, 2016 Gene Walden, Senior Finance Editor, and Jeffrey Branstad, CFA, Senior Investment Product Strategist, Thrivent Mutual Funds No question, index funds have enjoyed strong performance the past seven years during the second longest bull market run in U.S. history. But if the market should stumble under the weight of the recent tepid economic conditions and the prospect of rising interest rates, a new Thrivent Mutual Funds Active vs. Passive Study, suggests that index investors may be well served to consider switching their dollars to actively managed funds. The study shows that during the two market crashes of the 21st century, the S&P 500 1 significantly trailed actively managed large cap no-load funds. In fact, as the exhibits demonstrate, the index wouldn t even have ranked in the top 50% in terms of performance during a single 12-month stretch of the dot-com crash of 2000-03 (Exhibit 1), and would have trailed its peer group during 93.1% of the global financial crisis of 2007-09 (Exhibit 2). As Exhibit 3 shows, the index trailed the universe of actively managed large cap no-load funds the majority of the time over the entire course of the volatile decade of 2000 through 2009. The S&P 500 is not the only index to experience subpar performance relative to actively managed funds during bear markets and extended periods. The study also focused on the Russell 2000 Index 2 of small stocks. While the Russell 2000 has done well versus the actively managed fund universe during most of the recent bull market, it would have ranked in the bottom (fourth) quartile of the small cap category during 90.3% of the 31 rolling 12-month periods of the dot-com crash. In fact, the index would have ranked in the bottom half of corresponding actively managed, no-load funds the majority of the time over the past 25 years, dating back to 1992, as Exhibit 4 illustrates. 1
Why now? If you re concerned that the long bull market run is winding down or that the recent rise in interest rates will continue, or if you re apprehensive about the uncertainty of a new administration, this may be the time to consider switching from index funds to actively managed funds. While past performance is no guarantee of future results, as the Thrivent Mutual Funds Active vs. Passive Study demonstrated, the no-load actively managed funds in the study have done a better job of limiting losses than their corresponding indexes during the recent bear markets and volatile market stretches. To achieve even greater diversification, investors may consider actively managed asset allocation funds, which offer broad diversification across multiple asset classes. While diversification does not eliminate risk, it generally helps reduce losses during steep stock market declines. Six reasons to consider switching to actively managed funds 1. Flexibility. Some managed funds have done better than index funds during down markets due, in part, we believe, to the fact that fund managers have had the ability to make some adjustments in their portfolios to reduce the stocks or sectors that appear the most problematic. Investment managers can also use risk management techniques and diversification that seek to provide similar returns to the market with lower risk and volatility. 2. Help when needed most. A rising tide lifts all boats. Ever since the Federal Reserve launched quantitative easing activities intended to stabilize the economy and lower interest rates, all of that extra capital in the system has flowed to equities across the board, boosting market returns while greatly increasing correlations among stocks. That means that all equities, even stocks that many active managers think are unattractive, have generally gone up together, with higher risk companies that carry more debt on their books actually leading the way as the low interest rates have distorted the risks inherent in holding too much debt. That s been an advantage for index funds, since they own all equities, even those presumably higher risk stocks that active managers are avoiding. But while an index fund may (or may not) offer better returns in a bull market, active managers tend to provide their greatest value during bear markets when investors need their help the most. Normally, and particularly so in bear markets, stocks experience a wide variety of rates of return, meaning that index funds will be exposed to both the good performers and the bad, while active managers have a better opportunity to avoid those bad performers. 3. A better chance to beat the market. The fact is index funds perpetually trail the market by a small margin. Their costs, while minimal, create a small differential between the market performance and their own returns. As the study demonstrates, in any given year, actively managed funds can, and have, outperformed the market. 4. Active funds have responded by lowering fees. Actively managed mutual funds have responded to the low fees of index funds by lowering their own fees over the past 20 years. According to the Investment Company Institute, the average equity mutual fund expense ratio was 1.08% in 1994 and 2
dropped to just 0.68% in 2015. 3 The lower fees would add, on average, about 0.40% per year to the returns of actively managed funds. 5. Asset class diversification. One of the primary principals of prudent investing is diversification. While an S&P 500 index fund may provide diversification across 500 blue chip stocks, it wouldn t include small stocks, foreign stocks, bonds, REITs or other types of investments that could bolster an individual s portfolio s performance when the blue chips are down. How many index funds would it take to mirror the entire market? You would need an international fund, emerging markets fund, small stocks fund, and mid-cap fund, along with some bond funds and even then, your portfolio would probably have some gaps. Once you ve crossed that line by building a broadbased portfolio of index funds, you re no longer managing passively you re managing actively even if you re building your portfolio with passive funds. 6. Limiting market losses can speed up your recovery. Actively managed funds may not always cut your losses. But if you are successful in reducing your losses in a down market through an actively managed fund, the road to recovery becomes much easier. In fact, the bigger the loss, the more difficult it becomes to recover from that loss. For instance, for a 5.00% loss, you would need a gain of 5.26% to restore your portfolio to its previous level. But with a 20% loss, you would need a gain of 25% to get back to even; a 30% loss would require a gain of 42.9% to fully recover; and a 50% loss would require a 100% gain to bring the portfolio back to its previous level. In terms of pure long-term performance, index funds may (or may not) have a slight edge. But when the chips are down and the markets are reeling, the Thrivent Mutual Funds study suggests that you may be better served to have an active manager in your corner making the crucial decisions. Results The exhibits below summarize some of the key results of the study during the dot-com crash, the global financial crisis and the decade of 2000-10. The exhibit headings include: Lipper funds category ( large cap core or small cap core ), index (S&P 500 or Russell 2000), the four performance quartiles (the higher the percentage the worse the relative performance), and the average percentile ranking. The average percentile ranking is not tied to the quartile rankings, and provides a different vantage point on the comparative performance. It measures the average percentile of how they ranked over the given period of time. As with the quartile rankings, a lower percentage indicates better performance while a higher percentage indicates worse performance. For example, in the dot-com crash Exhibit 5 below, the average percentage of the S&P 500 was 70.6%, which put it in the bottom 30% among all funds in that category. The Russell 2000 Index fared even worse with an 81.9% average percentage which means it would have ranked in the bottom 18.1% of funds in the small cap category. In the following exhibits, please keep in mind that the first quartile represents the best performance and the fourth quartile represents the worst. For example, in Exhibit 5 you will see 0.0% in the first and second quartiles for each of the two indexes. That indicates that neither the S&P 500 nor the Russell 2000 would have ranked in the top half (first or second quartiles) in performance in their respective actively managed no-load fund groups during a single 12-month period from Sept. 31, 2000, through March 31, 2003. 3
To read the complete report, with full research and ranking methodology and expanded findings, go to Thrivent Mutual Funds Active vs. Passive Study. 4
Media contact: Callie Briese, 612-844-7340; callie.briese@thrivent.com All information and representations herein are as of Nov. 30, 2016, unless otherwise noted. Past performance is not a guarantee of future results. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance. The views expressed are solely those of the author and not necessarily those of Thrivent Financial or any of its affiliates, including Thrivent Asset Management, the investment adviser for Thrivent Mutual Funds, and Thrivent Distributors LLC, the principal underwriter and distributor for Thrivent Mutual Funds. Both Thrivent Asset Management and Thrivent Distributors LLC are wholly-owned subsidiaries of Thrivent Financial. Thrivent Distributors LLC is a registered broker-dealer located at 625 Fourth Avenue South, Minneapolis, MN 55415. The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by Thrivent Asset Management associates. Actual investment decisions made by Thrivent Asset Management will not necessarily reflect the views expressed herein. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investing in a mutual fund involves risks, including the possible loss of principal. The prospectus and summary prospectus contains more complete information on the investment objectives, risks, charges and expenses of the fund, and other information, which investors should read and consider carefully before investing. Prospectuses are available at ThriventFunds.com or by calling 1-800- 847-4836. The principal underwriter for the Thrivent Mutual Funds is Thrivent Distributors, LLC. Thrivent Distributors, LLC is a registered broker/dealer and member of FINRA with its principal place of business at 625 Fourth Avenue South, Minneapolis, MN 55415. 1 The S&P 500 Index is a market-cap weighted index that represents the average performance of a group of 500 large-capitalization stocks. Investors cannot invest directly in an index. An index is unmanaged and an investment cannot be made directly in an index. 2 The Russell 2000 is described by FTSE Russell as the 2,000 stocks that rank in size (market capitalization) from the 1,001st-largest U.S. stock through the 3,000th-largest U.S. stock. 3 Fee rate study conducted by Investment Company Institute; released March 2016. (https://www.ici.org/pressroom/news/16_news_trends_expenses) 1654307-113016 5