It’s no secret that passive investments, such as exchange-traded and indexed funds, have become more popular with investors over the past 10 years.
Such funds require very little to no intervention by investment managers and, therefore, have much lower management fees than the classic mutual fund structure.
The trend of choosing passive investing has evolved to become part of many organizations’ pension plan investment structure. The reasons include:
- Plan members are requesting the funds;
- Brokers and consultants are suggesting them as additions to the investment menu; and
- Many asset allocation and target-date funds now have indexed options.
On top of those factors, there are a number of other reasons why group retirement plans have started adding passive options to their fund menus.
First, employers feel more comfortable with indexed funds on the menu because they have less of a fiduciary burden. With active fund managers, they have to regularly monitor their performance versus that of their peers and their benchmarks. There also has to be company willingness to keep fund managers on the menu during underperforming years. Sometimes, it will be necessary to remove fund managers from the menu or to replace them, and those decisions can weigh heavily on a pension committee or on a plan sponsor.
With indexed funds, the return is what it is. It’s the benchmark. There’s no reason to explain why it varied from its mandate or returned less than its peers did. And it’s easy for the employer and employee to understand the performance of the fund.
Also, regulations around fee transparency continue to become stricter in both Canada and the United States. Plan sponsors would do well to have passive funds on their investment menu because the fees are lower than actively managed products. As well, there’s very little need to justify the fees against the activity within the fund or versus performance.
For employers that are introducing a new retirement plan or revising their fund lineup, consider including an indexed fund offering at least the basics — Canadian, U.S. and foreign equity, as well as bond index funds. Doing so will create more simplicity in the plan and give employees what they’re asking for. As well, lower fees and greater transparency are a trend that’s not going away, so employers that choose those funds also satisfy those requirements.