Morningstar - Q2 2023 - 12

Dispatches
at least, past performance was indicative
of future results.
Should Small-Value Investors Just Index?
For investors, however, the performance of active
funds is what matters. Even today, index funds
claim only about half of small-value assets. In 2002,
they accounted for almost none. Thus, most
of the gains enjoyed by small-value index funds
exist only on paper. Shareholder profits have
depended on the fortunes of the group's actively
managed funds.
EXHIBIT 3 evaluates three groups of actively
run small-value funds. The first basket contains all
funds that existed from 2002 until 2022; the
second holds only lower-cost funds, defined as
those that carried expense ratios of 1.00% or
less throughout the period; and the third consists
of the five all-weather funds.
The format resembles that of the previous
table. The results are relative. Positive figures
indicate that the active-fund average
bested the index-fund average, with a negative
outcome depicting the reverse. The table
also displays the difference in expense ratios.
Predictably, the index funds hold a
comfortable advantage.
In aggregate, actively run small-value funds
kept pace with their indexed rivals. However, 40%
of the active funds that existed in 2002 have
since disappeared. In addition, of those funds
that persisted, one fourth returned less than
the worst index fund. In other words, only half of
the active funds managed the simultaneous
feat of surviving the 21-year period and outgaining
the last-place index fund.
Investors should likely have indexed. Unless
they had selected the sole index fund that folded
its tent (which almost no one did, as that fund
was tiny), doing so would have brought them an
annualized return of at least 7.77%. Half
the active funds failed to achieve that outcome.
Cheap active funds, on the other hand, were a
plausible alternative. Eleven of the 15 funds
survived, with overall results that closely matched
the index funds' and modestly better bear-market
performances. As Jack Bogle often said, low-cost
index funds succeed not because they index but
because they are low-cost. With small-value
stocks, actively managed funds are competitive
when they are offered at the right price.
The all-weather funds, of course, were easily
the best of the three investment baskets.
Unfortunately, it would have been challenging
to identify those funds in advance. Only three of
the five funds had existed for even five years
before 2002, and none of them boasted particularly
impressive track records. Investors would have
needed to anticipate that those funds would
shine, although their past performances offered no
such clues. That would be a tricky assignment.
This article, in contrast, aims to be practical. It
shows that, despite unfavorable publicity,
small-value U.S. stock funds have continued
to post competitive gains that are accompanied
by bear-market resistance. Investors who
wish to participate can do so by indexing or buying
an established, low-cost actively run fund. K
John Rekenthaler is a vice president at Morningstar
Research Services LLC. He is quick to point out that the
views expressed in Ivory Towers are his own.
Insights From the
2023 Retirement
Plan Landscape Report
What our newest
research shows about
retirement plan lineups.
Lia Mitchell
POLICY
Many people in the United States invest
solely through their workplace retirement plan.
As a result, looking at the U.S. retirement
system broadly can provide insight into investors'
individual experience. In our recently published
second annual review of the U.S. privatesector
retirement plan landscape, we look at
trends in the defined-contribution and definedbenefit
segments. Here, we focus on
developments in the investments available in
defined-contribution plans.
EXHIBIT 3
Small-Value Funds: Active Versus Index
Annualized Total Return %
All Active Funds Advantage
Cheap Active Funds Advantage
All-Weather Champions Advantage
2002-22
-0.24
0.23
0.29
Source: Morningstar Direct, author's calculations. Data as of Dec. 31, 2022.
2002
1.01
2.96
2.82
2008
-2.08
0.65
9.74
2022 Expense Ratio
1.70
2.02
10.20
-0.92
-0.46
-0.86
CIT Usage Continues to Grow
The incorporation of collective investment
trusts, or CITs, into plan lineups is not a new trend,
but the types of plans growing their adoption
appears to be. Morningstar has been talking
about CITs for a while, most commonly in relation
to stable value and target-date strategies.
Manager research analysts discussed CIT assets
alongside their mutual fund counterparts of
the same strategies in the 2016 Morningstar
target-date landscape report, and the segment has
only grown from there. But the subtle difference
in the most recent year's data is that there has
been a slight uptick in the usage of CITs outside of
the largest plans. As shown in EXHIBIT 1 , the
largest plans have been moving assets into CITs
aggressively over the past decade, but growth in
market share was minimal for smaller plans.
From 2012 to 2019, looking at all but mega plans,
assets in CITs and mutual funds both grew
at roughly the same average year-over-year rates-
7.3% and 7.9%, respectively. In the following
12
Morningstar Q2 2023
https://www.morningstar.com/authors/208/john-rekenthaler
Morningstar - Q2 2023

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