Active Management Subtracts Value

Passive management advocates will be happy to hear that the target date industry has failed to do a good job with its actively managed funds.  To measure this, TDA defines a Selection measure.  It is very simple, and measures the actual return on a fund against the return with the same asset allocation using index funds.  The difference is the Selection effect.  Surz says “active management is a persistent and consistent detractor of performance.”

The cost of active management is generally between 60 and 70 basis points per year, although it is as high as 150 basis points for longer-dated funds (which maintain higher allocations to equities).

Three firms (Vanguard, Nationwide, and Seligman) utilize exclusively index funds in their target date offerings.  We noted that Vanguard had a negative Selection effect, but this is an artifact of their particular choice of passive indices.  NestEgg, TDAX, and Wells Fargo buy individual securities in an attempt to replicate passive indices.

Interestingly, Russell scores the best among active managers, but their Selection effect is still negative.

The Best Ballerina in Waco

Israelsen says winning the competition among target date fund companies is like becoming the “best ballerina in Waco.”   We’ve never attended a ballet in Waco, but we suspect that good ballerinas are scarcer there than good high school football players.  There is clearly room for improvement among the target date providers.  Surz is careful to point out that he and his firm do not want to be hypercritical of the industry.  Surz believes that TDA has taken in important step with their offering of industry standard benchmarks for target date funds, and remains very optimistic about the role of these funds in retirement portfolios.

Nagengast stresses that target date funds are delivering results that are “much, much better than leaving individuals on their own and are moving the nation’s individual accounts to more prudently allocated positions, but they still have a way to go.”

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