index investing

That Thump You Heard Was Active Pounding Passive In 2020

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Guess what, the best performing U.S. stock mutual funds in 2020 were actively managed. As employers consider what they should stress this year in their employee education sessions, they may wish to keep this trend in mind.


Top stock funds of 2020


The Wall Street Journal reports that the stock fund with the highest returns in 2020 was the Morgan Stanley Inception Portfolio, which gained 150.60%. If you weren’t fortunate enough to own shares in that fund, there were a number of other funds that performed nearly as well.

The Baron Partners Fund returned 148.50%, while the American Beacon ARK Transformational Innovation Fund delivered nearly a 148% return. Meanwhile, the NASDAQ Composite posted gains of 43.64% for the year.


Large cap index returns vs. active in 2020


For comparison purposes, the Dow Jones Industrial Average (DJIA) rose 9.72% in 2020 while the Standard & Poor’s 500 (S&P 500) was up 18.40%.

Most U.S. large cap stock index mutual funds posted similar gains in 2020. For example, the Fidelity 500 Index Fund returned 18.40% and the Vanguard 500 Index Fund gained 18.37% in 2020.

According to the Wall Street Journal post cited above, the average actively managed diversified mutual fund returned 19.10% in 2020. And in its January 25, 2021, print edition, Barron’s reported that the average large company sustainable fund returned 20%.

Barron’s reports in the same issue that the average large cap sustainable fund returned 14.6% over a three-year period, while the S&P returned 14.1%.


In addition, index investing can be expensive


No one should ever pay a financial advisor for an indexed investing strategy. As this example illustrates, after the advisor’s fees are deducted from returns, investors are guaranteed below-market performance. Why would anyone want to lock in performance each year that is guaranteed to fall below market averages?


Why index investing no longer dominates


Cathie Wood, whose firm manages the American Beacon ARK Transformational Innovation Fund, believes index investing is one of the most massive misallocations of capital in history. She characterizes index investing as backward looking with indexes like the S&P 500 tracking older firms while leaving out powerhouse tech companies.

In the recent past, index investing yielded results on par or slightly worse than active investing. Last year, the pandemic fueled rapid digital/technology adoption. Super-growth tech companies experienced extraordinary growth. Other sectors of the economy have not seen similar growth.

As a result, security selection became much more important to fund performance.


An example


I like to use the T. Rowe Price New Horizons Fund as an example of why most plan participants should not adopt a 100% index investing approach. The New Horizons Fund is an actively managed mid-cap growth fund that returned 57.72% for 2020 versus its benchmark return of 35.58%. (This fund’s performance is measured against the Russell Mid-Cap Growth Index).

While that performance is astounding, you may wonder how the fund performed over a longer period. So let’s look at the fund’s 10-year performance.

For the 10-year period ending December 31, 2020, New Horizons returned 20.70% versus its benchmark return of 15.04% (the S&P 500 returned 13.60% over the past 10 years). That is more than 5% per year for 10 years versus the Russell Mid-Cap Growth Index and more than 7% versus the S&P 500.


Continuing in 2021


Certainly some returns for super-growth tech companies have been pulled from the future into the present due to the accelerated adoption of digital/technology. Many experts believe the pandemic resulted in five years’ worth of digital/technology evolution occurring in 2020 alone.

Right now it appears that the pandemic will continue for the majority of 2021, extending the quickened pace of digital/technology adoption. Welcome to the age of disruptive innovation investing — an occurrence that favors an active investment approach.

Make sure you talk with your investment advisor about how they will communicate this trend to your plan participants during your annual employee education sessions.


This is not investment advice


None of the investment options discussed in this post should be considered as investment recommendations.

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About the Author

Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton is an award-winning 401(k) investment adviser with over 30 years of experience. He has consulted with many Fortune 500 companies, including: Aon Hewitt, Apple, AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Corporation, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or bob@lawtonrpc.com.

About Lawton Retirement Plan Consultants, LLC

Lawton Retirement Plan Consultants, LLC (LRPC) is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to employer retirement plan sponsors. The firm specializes in Socially Responsible Investment (SRI) strategies for retirement plans and is a pioneer in the field. LRPC currently has contracts in place to provide consulting services on nearly a half billion dollars in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com or visit the firm’s website at https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, a plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice, and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.