Russ Kinnel: Where Active Funds Work and Where They Clearly Don't
How the fund industry has changed, whether ETFs will rule the roost, and the perils of fund-company mergers.
In a recent conversation on The Long View podcast, we spoke to Morningstar's longtime head of fund research, Russ Kinnel, about a wide range of topics, including what changes he's witnessed over his nearly three-decade career as a leading fund analyst.
In this excerpt of our conversation, we ask Russ how investors should go about the process of determining whether they're cut out to pick active funds. We also ask Russ for his perspective on where the case for indexing is more open-and-shut.
The complete podcast recording and transcript also cover a number of other topics, including whether the mutual fund will go the way of the dodo, fund managers' power of persuasion, the perils of fund-company mergers, what will stem the tide of outflows from mutual funds, whether this is the late 1990s all over again, and more.
Ptak: One of the things that I'm sure the past two decades plus has reinforced for you is that picking active funds is difficult. And that's a challenge that everyday investors face. What would be your guidance to an investor that is trying to self-assess and ask themselves whether they're cut out to choose active funds versus just choosing an index fund or an ETF? Do you think it's fair to say that the vast majority of individual investors, let's say, should be indexing instead of trying to choose an active fund? Or do you think that sells them a bit short?
Kinnel: I would say a lot of people should have a good part of their portfolio in passive strategies. I'll put it that way. Because passive works nicely in a couple of ways. One, they're lower maintenance. Not everyone has the time to do the research. So, we can do a lot of that work. But you still need to do more work if you're picking an active fund because managers can change, strategies can change. Whereas an index fund, the well-designed ones anyway, just keep on chugging and are much lower maintenance. I think it does take more work, and it probably takes a bit of dispassionate skills that you have to be willing to not get too involved, and I think, also have a decent strategy. In other words, have a plan, know what that plan is, know each fund's role in that plan. So that when problems arise, say you're looking at your funds in March 2020, you don't panic and sell every value fund, you don't panic and sell every high-yield fund. It's also about your disposition. I think a lot of investors can use active funds. If you don't have a lot of time, it makes sense to lean more heavily on passive for sure.
Benz: What are the areas where you would say “by all means go passive”? And then what are the other areas where you would be more inclined to say, “I think you could have a reasonable outcome with an active fund”? So just in terms of categories or asset classes?
Kinnel: I think, obviously, the first place that passive makes the most sense is large-cap equities, both U.S. and foreign. The record of passive funds there is outstanding. I think it makes a lot of sense there. Myself, I own some active funds in that space. But I think, by and large, passive ought to be at the core. Another area where passive works quite well is high-quality bonds. I think it probably makes more sense to have passive there. But then you might add, say intermediate core plus or some other funds around there, because the further you get out from that core of bonds, the more active makes sense. I think emerging-markets equities make a lot of sense for active; we've seen passive hasn't worked quite as well there. There are some other strategies where for one reason or another passive just doesn't work well. Sometimes it's just hard to build a good benchmark. Bank loan, high yield--those are areas where passive really hasn't solved all the challenges there. And so, I do think that around the edges, there are some places that are really ripe for active management.