Pass(ive) the funds, please

For What It's Worth -

Forwarded this email by a friend? Subscribe here.

Happy Thursday!

For those of us in the US, it’s T-minus 27ish hours until the start of the long Memorial Day weekend (not that we’re counting down or anything). To help you kick off the official start of summer on a high note, we’ve been weeding through this week’s ominous headlines about the debt crisis, scorching summer forecast, and orcas attacking boats to find some cheer. Luckily, we didn’t have to search long.

A wave of new research shows that, even with companies saying less as they try to avoid being pulled into the culture wars, there’s still a lot of momentum for values-aligned investing and gender equality:

  • Healthy employees, healthy bottom line: Companies that prioritize employee wellbeing show a superior return on assets, generate higher profits, and command higher valuations, according to Oxford research. The researchers compiled a virtual stock portfolio of 100 top companies for wellbeing and found it outperformed the S&P by 20% and the Nasdaq by 30% between 2021 and 2023.
  • Investors prioritize social responsibility: According to a USC Center for Public Relations survey, 89% of investors believe companies have a responsibility to play a role in addressing societal problems.
  • Addressing racism boosts employee retention: Employees who see their employers as making a lot of progress on addressing racism and racial inequities are 39% more likely to want to stay working there for many years, finds an Edelman survey.
  • Girl-powered recovery: The share of women aged 25 to 54 in the US workforce hit a record high of 77.5% in April, reversing the pandemic-induced decline in women’s employment.

Here’s hoping the rest of your week flies by. We’ve got more news below, as well as a look at whether actively managed funds are worth it.

News you can use

Asking for a friend….

We know there is a lot to think about these days, and it can sometimes be a bit overwhelming. To help with those nagging questions and so you have useful resources at your fingertips, here are a few links to resources and past stories relevant in these turbulent times:

Figure in Focus: 28

That’s how many states introduced some variety of Right to Repair bills this year. Three other states — Massachusetts, New York, and Colorado — have already passed laws to tackle the corporate monopoly on repairs, but the one signed yesterday by Minnesota’s Governor Walz is said to be the most comprehensive and groundbreaking with the potential to help people globally.

Should consumers be able to open up and fix their machines themselves or get independent help to do so? For this to happen companies would have to provide everyone access to spare parts, tools, diagnostics, and manuals. Those in favor say more repairing will reduce electronic waste (which is outweighing the Great Wall of China each year), preserve the value of products, support repair, reuse, or resale businesses, and protect owners’ rights.

The movement has been gaining ground, and shareholder activism has had a part to play. This year, the American Farm Bureau Federation has negotiated and signed agreements with AGCO, Japan’s Kubota, John Deere, and CNH Industrial Brands to protect farmers' and ranchers' rights to repair their own farm equipment. Together this covers roughly 70% of the agricultural machinery sold in the country. Meanwhile, Microsoft broke with the other Big Techs recently and showed its support for a bill in Washington state, calling Right to Repair “a priority” for the company.

Fund-amentals: active vs. passive

While ordering a mixed drink at a bar, are you better off with the classic cocktails on the menu, or should you trust the bartender to create something special just for you that will cost a little more? If you’re on a road trip, should you play a Spotify playlist or ask your melomaniac friend to make one? Sometimes direct involvement can lead to something amazing… and sometimes sticking with the tried-and-true is the safer, more satisfying path. The same is true for passive and active forms of investing. Every time you invest in a fund, you make a choice between the two. But what is the difference, and what should you know? Read on to find out.

Set on automatic or stock-pick funds

First, a few definitions: passively managed funds are designed to mirror the composition and performance of indexes, which are groups of assets that represent either a portion or entirety of a market/sector/industry. In the case of active funds, a professional financial expert handpicks the investments, decides their weighting, and trades them strategically to deliver the best returns possible. These fund managers also provide a benchmark index that they aim to outperform. For your reference, most ETFs are index-based and passively managed, whereas most mutual funds are actively managed.

Reminder: FWIW can help you learn more about indexes and how we use them as benchmarks.

How do they compare?

There are a couple of ways actively managed and passively managed funds differ. Knowing these differences can help you build a portfolio best suited to your financial goals and risk appetite.

Cost – A lot of time, research, and skill goes into actively managing funds, and that’s why they tend to have higher fees (expense ratios). Last year, the average expense ratio of actively managed equity mutual funds was 0.66%, and the average expense ratio for index equity ETFs was 0.16%, per the Investment Company Institute. Some asset managers are even offering passive mutual funds and ETFs with a zero expense ratio, like the Fidelity ZERO Total Market Index Fund and BNY Mellon US Large Cap Core Equity ETF. Cost is a significant consideration when choosing funds because high expense ratios eat into your earnings and your portfolio’s potential to grow.

Performance – Although you would think having a smart, accomplished person controlling a fund’s components and reacting to the market in real time would be a huge advantage, the data shows that humans just aren’t that good at predicting and timing markets, and the high management costs hurt the overall return of even the best performances. In 2022, less than half of all US active funds survived and outperformed their average passive peers, according to Morningstar. When you zoom out and look at longer time horizons, the data does not paint a sunnier picture. “Only one out of every four active funds topped the average of their passive rivals over the ten-year period ended December 2022,” said the report.

Tax efficiency – Because assets in actively managed funds are sold more regularly, they tend to attract more taxable capital gains. For this reason, experts advise holding them in tax-advantaged accounts like 401(k)s and IRAs. The FWIW archive is rife with more investing tax tips.

Transparency – With passive funds, you know exactly what goes into them, but active fund managers typically keep their stock picks secret. ETFs have to disclose their holdings daily, but mutual funds only need to do so on a monthly or quarterly basis.

When active funds are worth it

Many experts say the data makes it clear that passive funds are a less-risky bet on average, and this is reflected in the direction the money is flowing. Billionaire Warren Buffett, perhaps one of the best active investors of our time, regularly advises buying index funds and sitting still.

So, does this mean you need to write off active funds completely? Not exactly. Active funds that outperform the market do exist, and some argue that these funds have an edge when the economy is in a recession. Financial experts say that smartly sprinkling them in can be beneficial, especially in the following cases:

Finding the market-beating hidden gems: We know US large-cap active funds have very low success rates of beating their benchmarks over the long term, but Morningstar’s Active/Passive Barometer study shows that in some areas of the market, the odds of picking winning active funds are better, like US and global real estate, bonds, foreign stocks, and US small growth. Active fund managers may have an advantage in less-understood niche areas where expertise and research matter. For example, they may have "boots on the ground" in the foreign countries where they invest, Dan Genter, CEO and chief investment officer of RNC Genter Capital Management, told Kiplinger. This gives them a better understanding of local economies and companies with growth potential.

ESG and faith-based investing: Experts say certain active funds could also help you better align your values with your portfolio and achieve impact.

“The fees that you are paying are being used to actually shift the policies and practices of the companies,” said As You Sow CEO Andrew Behar. In his experience, smaller ESG active fund managers, like Trillium, Calvert, and Green Century, use their proxy votes to support shareholder resolutions on issues like climate and social justice and also act as shareholder advocates, engaging with companies and filing resolutions on things like palm oil, animal rights, and gender equality. “The indexes tend to vote with management,” he said about the giant asset managers that dominate the ETF market, like Vanguard.

“An actively managed strategy has a greater ability to emphasize the broader concept of sustainability than a passive ESG strategy has,” said Morningstar’s sustainable-investing analyst Jon Hale, pointing out that there are some “really good” active managers who have been able to outperform passive strategies on a regular basis.

Even many faith-based asset managers, like Saturna Capital and GuideStone Funds, only provide actively managed mutual funds, which may be regularly reviewed by religious consultants and advisory boards.

Ultimately, deciding if an active fund would be a better choice than passive alternatives with similar goals, like the iShares USD Green Bond ETF, the Global X S&P 500 Catholic Values ETF, or any of the many ETFs listed in FWIW’s Guide to Cleantech Investing, is complex and should involve a deeper look at what the fund offers, its fees, the manager’s values and track records, and a conversation with your financial advisor. Also worth considering are the relatively new ETFs from small sustainability-focused providers, like the Engine No. 1 Transform 500 ETF that helps investors hold companies accountable and Calvert’s ETFs that track their own proprietary indices with fees lower than those found in most actively managed funds.

Before you go -

How many comedians does it take to make climate change funny? Yale Climate Connections has the answer to that trick question.

** FWIW team members own shares of Google, Intel, JPMorgan Chase, John Deere, and Microsoft.

Want to learn a bit more about the writers behind FWIW? Have an idea you would like us to cover in the future?