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By Christine Benz | 04-16-2015 11:00 AM

Get the Best Out of Active and Index Funds

In this 60-minute roundtable report, Morningstar's Russ Kinnel, Ben Johnson, John Rekenthaler, and Christine Benz dissect indexing's popularity, index versus active fund performance, and how investors can effectively blend the best of both in a portfolio.

Note: This video is part of Morningstar's April 2015 Active, Passive, and In-Between special report.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Index funds have been gaining market share at the expense of actively managed products for the past several years. Joining me to discuss what the data say about active- versus passive-fund performance as well as how investors might hold the two together in portfolios is an all-star roster of thought leaders at Morningstar.

Russ Kinnel is here. He's director of fund research for Morningstar, and he also heads up the Morningstar FundInvestor newsletter. Ben Johnson is also here. He is director of global exchange-traded fund research for Morningstar. Last but not least, John Rekenthaler is here. He is vice president of research for Morningstar.

Thank you all for joining us today. This is a really important topic, and we're really excited to hear your thoughts.

Russ Kinnel: Glad to be here.

Benz: Let's start by talking about what we've seen in terms of fund flows. We've really seen tremendous flows going to passively managed products--both traditional index funds as well as exchange-traded funds. I'd like the panel's views on why investors seem to be preferring index products. Russ?

Kinnel: I think you're right. We really are looking at a more than 10-year trend of passive funds just continuing to gain steam, and I think it's partly that we've seen star managers come and go. I think people didn't like how some active funds [behaved] in bear markets. And I think another part of it is that it used to be the only people who were profiting from indexing were Vanguard fundholders, but then ETFs came out and, all of a sudden, fund companies and advisors had ways to attach their own fees to indexing and they could profit. And so now you see a lot more press, a lot more coverage, a lot more advertising around index funds. So, that's another part of it, too. Ironically, the addition of fees to indexing has led to greater popularity of indexing.

Benz: Ben, I'd like your take on the advisor's role in all of this. To what extent do you think advisors changing their business models has driven these flows into passively managed products?

Ben Johnson: I don't think you could [overemphasize] just how much the change in advisors' economics has influenced this trend. So, when you think about the all-in cost of advice, what you're seeing is sort of a squeezing of the balloon. So, as we move from transaction-driven models in advice channels to fee-based advisory models, what you're seeing is that the cost of the individual products is getting squeezed. You're seeing those costs, those expenses, manifest themselves in a fee based on assets under management, typically. So, what that has done is it's driven down the cost of the advisor's tool kit; they're looking for lower and lower-cost implements all the time, and that has benefited, disproportionately, index funds and exchange-traded funds.

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