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Should Active Managers Panic? One Star Says No

Nearly two thousand fund managers are gathering in Chicago to talk strategy in a tough market — and an industry-wide rift.

Photo by: Jennifer Leigh Parker for CNBC.com

The pros here at the Morningstar Investment Conference are mostly active managers who aim to beat the market. As a group, they have seen $172.3 billion leave their accounts, while $47 billion has gone into passive funds (which simply match a market index) over the past year, according to Morningstar data.

What's more, a recent report from S&P Indices researchshows the majority of active equity and bond managers have lagged behind the benchmark indices they're paid to beat for five years running.

But Michael Hasenstab, senior vice president of Franklin Templeton's Fixed Income Group, is not your average active manager. He's arguably one of the best in the business, and kicked off the conference Wednesday as keynote with very careful optimism.

"Should we panic? You should if you think the euro is about to split apart, expect an Italian credit event, or that China will have a hard landing. If you think that will all happen, go buy some shotguns," says Hasenstab.

Though his tone is tongue-in-cheek, he lists the reasons why he doubts that any of these scenarios will happen.

The euro, he expects, will remain intact, given the "huge war chest" of the European Central Bank. "It prints its own money. They can provide an almost unlimited amount of liquidity to ringfence a Greek financial meltdown," he adds.

Michael Hasenstab, Portfolio Manager, Franklin Templeton
Source: Franklin Templeton
Michael Hasenstab, Portfolio Manager, Franklin Templeton


"It's going to be messy, but it's not Armageddon.There is reason to be a little optimistic. The [European debt] crisis has triggered some good changes. We can exploit these changes, with a longer term vision," says Hasenstab.

Hasenstab has plenty of incentive and pressure to implement his vision. He co-manages over $24 billion in the Templeton Global Bond Fund , which invests in government bonds based in local currencies. The fund has outperformed its peers consistently for more than 10 years, but in 2011 it hit a rough patch, underperforming its category index by 7.55 percent.

Year to date, the fund is bouncing back a bit, beating its index by 1.37 percent, according to Morningstar data.

Investor capital flows, also tracked by Morningstar, are favoring bonds over equities right now in a big way — putting Hasenstab's bond fund on the right side of the market.

Of the $147.9 billion dollars that flowed into US mutual funds this year over $106.5 billion went into taxable-bond funds, while equity funds saw outflows of close to $34 billion.

Despite Hasenstab's fairly persuasive argument, retail investors' choice to stay out of active equity funds seems a logical choice. Why pay an active manager to try and beat the S&P 500 index —arguably the most liquid, transparent and well researched equity market in the world — when a passive index fund can replicate market performance (not beat it) for a much lower management fee?

The answer might explain why the passive index mutual fund giant Vanguard saw the largest inflows this year to date —$52.3 billion – nearly nine times more than Franklin Templeton, and four times more than JPMorgan's, according to Morningstar's ranking of the"Top-10 Open-End Fund Families."

"Its very hard for an active mutual fund to perform better than the index. For the ordinary investor, passive investment is the best choice," said Frank Luo, global head of research for S&P indices, in a separate interview with CNBC.

The average fee of an active fund is about 120 basis points, or 1.20 percent, whereas the average price of a passive fund is 0.25 percent, according to S&P research.

But an argument can still be made for active management, and Hasenstab anchors his on the investment opportunities of less-transparent emerging markets, which may merit an manager's expertise.

"If you're worried about credit risk, emerging markets provide better opportunities," says Hasenstab. "Most have, since the crisis of the late 90s, undertook a decade of tough fiscal reform, and now have much less debt to GDP than the developed markets."

Hasenstab, in particular, is interested in Asian markets, where there are relatively higher interest rates, and there's no central bank busy printing money.

"Over the long term, a big part of our strategy is getting a yield without taking a lot of credit risks," he says.

Whether investors go active or passive, mutual funds play a crucial role in US family net worth, which according to last week's Federal Reserve report is no higher now than it was back in the early 1990s. With savings accounts offering zero interest, a strategy for mutual fund returns couldn't be more welcome.

Over the next two days of summer in Chicago, the best and brightest industry players will have a chance to weigh in on Hasenstab's thinking, as well as voice their best ideas about the best investments.

"These are pretty tough times for active managers," says Joe Mansueto, CEO of Morningstar. "This conference allows you to evaluate whether these managers are worth the active fees. We think the very best managers are, but you can be the judge of that."

Tune in starting at 7:40am ET on Thursday, June 21 to see Tyler Mathisen, co-anchor CNBC's of "Power Lunch," report live from the annual Morningstar Investment Conference.

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