Getting Active in Indexland

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Vanguard built its name with index funds, but its heritage is with active management.

The family's oldest funds, including Vanguard Wellington VWELX and Vanguard Windsor VWNDX, are actively managed, and much of its current lineup consists of actively managed offerings. Vanguard's assets, as of Sept. 30, 2010, are split almost down the middle, with a little more than $537 billion, or more than 45% of total mutual fund assets, in actively managed funds, and about $639 billion, or more than 54% in index funds, according to Morningstar data. Despite its status as the destination for many investors on the latter side of the active/passive investing debate, Vanguard takes both sides.

Some diehard indexers find it hypocritical. How can the firm that has done more than any other to popularize the notion that most active managers can't beat their indexes over time offer managed funds alongside passive ones? Aren't those active funds doomed to fail? The answer is no, according to a comparison of Vanguard's managed funds and index funds.

Broadly Speaking
To see how Vanguard's active funds have stacked up against its index mutual funds, I  compared the returns of the managed mutual funds with the index funds in their respective categories. I wanted to see how you fared in recent years if you picked a Vanguard active fund over a rival index fund in the family. I looked at data through midyear 2010 but focused on long-term periods.

Odds are good that you fared well. Grouping the funds by broad asset classes--domestic stocks, international equity, and taxable bonds (Vanguard has no municipal-bond index funds)--and asset-weighting their returns show that Vanguard's actively managed funds have been competitive with their indexed counterparts. In the domestic-stock group, passive funds beat the actives in the year-to-date and trailing-year periods through the end of June 2010; but the managed funds had the edge in the longer three-, five-, and 10-year spans. Among international-equity funds, the actives won the year-to-date, one-, and 10-year time periods, while index funds prevailed in the intermediate term. Indexing, however, had the edge among taxable-bond funds, prevailing in all trailing periods save the year ended in June.

Winners
To see how consistent the active funds have been, I looked at rolling returns. Vanguard has 25 actively managed funds that have been vying for dollars with sibling index funds for at least five years. (I used investor class shares and didn't count the family's tax-managed funds, which are quasi-index funds, or its funds of funds.) Fifteen of them have beaten the oldest index fund in their category in more than half of the rolling five-year periods in which they have contended.

There are 19 actively managed funds that have competed with passive alternatives in their peer groups for at least 10 years; 12 of them have bested the index fund in more than half of the rolling 10-year periods. Seven of the actively managed funds beat the index fund in all the periods.