How do Vanguard's actively managed funds stack up against its index funds?
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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
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.
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.
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.
Vanguard Capital Opportunity
Vanguard US Growth
Other funds lagged their rival index funds over more than three fourths of their rolling five- and 10-year periods but put up a better fight than US Growth. Vanguard Growth Equity
A few funds upsides didn't make up for their downsides versus their competing index funds. When Growth Equity lost to Growth Index in 89 of 92 rolling 10-year periods, its deficit was much wider, on average, than its margin of victory in the three rolling periods in which it prevailed. Vanguard Capital Value
Finally, to see whether Vanguard's active funds did better or worse than expected, given the level of risk they were taking, I looked at their alphas relative to the oldest index funds in their peer groups. Over the trailing five years ended in June, 13 of the 25 active funds with index rivals had positive alphas, meaning they performed better than expected relative to the passive fund, given the active funds' risk levels. In the trailing 10-year period ended in June, 11 of 19 funds with index alternatives had positive alphas relative to the passive options.
Once again, Capital Opportunity, PRIMECAP, and Wellington did far better than expected, given their risk profiles, while US Growth and Growth Equity did far worse than expected. Explorer, which has good results versus its category and until recently was an Analyst Pick, posted negative alphas versus Vanguard Small-Cap Growth Index
Vanguard and even its founder, Jack Bogle, have never said it's impossible for an active fund to beat its benchmark over time. Rather, they have contended it's difficult to know in advance which active funds will outperform. Even if you think you can find winners, they say, it's best to favor funds that share some of indexing's most salient traits, such as low costs, diversification, and lower-than-average turnover. That describes most of Vanguard's active funds and helps explain their success versus their passive siblings.
It pays to be selective with Vanguard's active options, though. Funds subadvised by PRIMECAP and Wellington have been consistent winners. Though some big funds with multiple subadvisors, such as Windsor II, have been able to stay in the hunt, others, namely Explorer, are nearly index funds themselves. And there are recently overhauled funds, such as US Growth, that still have poor long-term records. Overall, there's reason to believe in many of the active funds offered in the Vatican of indexing.
Dan Culloton is an associate director of fund analysis for Morningstar.
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