It isn't usually newsworthy when a mutual fund company rolls out a study extolling the virtues of its active managers.
But it is a bit more surprising when that mutual fund company is best known for its passively managed investments.
That is why, when The Vanguard Group Inc. made the case for its actively managed equity funds in a newly published report, it may have caused some financial advisers to do a double take.
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Vanguard, of course, is the largest provider of index funds, which are the antithesis of active management.
“We're almost synonymous with indexing, but a quarter of our equity assets are in active funds. Not a lot of people know that,” said Daniel Wallick, a principal in the investment strategy group and co-author of the research paper.
Passively managed index funds and exchange-traded funds make up the bulk of Vanguard's $2 trillion-plus in assets, but the firm has a much larger group of actively managed equity funds than one might expect.
INDEX KING BOGLE
In fact, the active equity funds alone, which have about $350 billion in assets, are big enough to be the foundation of the fifth-largest mutual fund company.
Even more surprising, the majority of those funds were launched before the godfather of indexing himself, John C. Bogle, stepped down as chief executive in 1996.
He has been one of the biggest advocators of using low-cost index funds, primarily because he worries that investors pay too much for active management and pay too much attention to past performance.
Vanguard's new research report, not surprisingly, touts its active- equity-fund focus on low costs as the attribute that gives it a leg up. The paper points out that because nearly all Vanguard equity funds are subadvised by third-party managers, the firm avoids going gaga over past performance when selecting managers and focuses on more qualitative measures.
BEATING BENCHMARKS
As a group, Vanguard's active equity funds have outperformed their respective benchmarks by an average of 88 basis points a year over the past 10 years, according to the company.
Assuming that the average index fund or ETF has an expense ratio in the 15- to 20-basis-point range, the active funds' outperformance jumps closer to 1% annualized.
The key to the active funds' success is finding top talent at a low cost, Vanguard contends.
The low-cost focus shouldn't sound new, because it is one of the cornerstones of Vanguard's arguments for passive index funds and ETFs.
Vanguard's research shows that the lower a fund's cost, the better chance of it beating its benchmark.
Mutual funds with the lowest cost, those with expense ratios in the bottom 10th percentile, have beaten their benchmark 32% of the time, while funds with costs in the lowest 50th percentile have beaten their benchmark just 23% of the time.
There is also an added twist to Vanguard's active funds.
They come with performance fees, which just 3% of all active funds have, according to Strategic Insight.
The performance fee structure ties a manager's fee to its performance. So the fee is higher when it is outperforming and lower when it is underperforming.
Picking a fund with a low expense ratio is only part of the process in selecting the right managers, though.
Vanguard knows how tough that can be. The majority of its active funds are subadvised by other asset managers, rather than run in-house.
“You can't just look at track records,” Mr. Wallick said. “You need to get beyond the numbers and understand how they operate and why they operate that way.”
Mr. Wallick stressed that investing in active funds isn't for the faint-hearted, despite the report's findings.
“You have to be comfortable with the variability of returns and willing to hold on over a long time period,” he said.
“There's no consistency in alpha. No one should expect that,” Mr. Wallick said.
Jennifer Failla, principal at Plannning Thru Divorce LLC, looks for the same low-cost and qualitative attributes in managers as Vanguard does, but still finds picking the right manager a challenge.
“I have a hard time finding managers I love,” she said.
That is something to which Vanguard can relate.
The Vanguard Growth Equity Fund (VGEQX), for example, has 10- and five-year returns that rank in the bottom half of all large-cap-equity funds, according to Morningstar Inc.
“You'll have variations in performance,” Mr. Wallick said.
“We looked at things on an aggregate basis,” he said. “Your experience might be very different depending on the fund.”
In other words, investors may want to stick to an index fund if they aren't big fans of the roller coaster.
