Vanguard is known primarily for its excellent, low management fee index funds, and justifiably so. I recommended Vanguard funds in my books and blogs. It remains my view that investors could achieve returns that would likely place them in the top 5 percent of all professionally managed money by simply purchasing three Vanguard index funds. I set forth the basis for this view in The Smartest Investment Book You'll Ever Read, in my subsequent books and in this blog, among others.
Vanguard's low fee structure has been very successful. It manages $1.7 trillion in assets, of which $960 billion is in index funds (56 percent) and $750 billion is in actively managed funds (44 percent). I have always been intrigued by the fact that Vanguard is a vociferous proponent of indexing, yet it offers both index and actively managed funds to investors. This seems incongruous to me. If Vanguard had the ability to select fund managers who could consistently beat the market, why wouldn't all its funds be managed in that manner? Index funds merely track a given index and achieve the returns of that index, less low transaction costs.
The vast resources and expertise of Vanguard make it an excellent case study. It can direct a huge flow of assets to active managers, making it one of the most desirable clients in the world. It has the ability to do extremely sophisticated research on all aspects of the performance of the active managers it is considering. With this in mind, I asked Vanguard how it went about selecting active managers for its actively managed funds.
A Vanguard spokesman summarized its impressive methodology as follows:
"We don't employ 'average' managers. Firms like Wellington, PRIMECAP, and Barrow, Hanley, Mewhinney & Strauss are world-class firms that follow well-defined strategies, executed with discipline and efficiency. And we exert considerable effort and resources selecting and overseeing these managers to improve the odds. And, most importantly, we acquire their skills at a very low cost and thus reduce the hurdle for outpacing the market. The average expense ratio for Vanguard's active equity funds is 0.41%."
When I pressed for more details, I was advised that Vanguard employs a "rigorous process that incorporates both quantitative and qualitative analysis."
So, how have these actively managed performed? Vanguard provided me with the following statistics for the ten year period ending April 30, 2011:
Many of the underperforming funds came close to their benchmark returns, but that is small consolation to investors who could have achieved benchmark returns, less transaction costs, with certainty.
This data is quite striking. One of the largest and most sophisticated fund families in the world, employing the most advanced models and cutting-edge analysis available, has approximately the same chance of picking an outperforming actively managed fund as you have in calling heads or tails in a coin toss.
When I dug deeper, it got worse. I asked Vanguard how investors could tell which of its actively managed funds would likely outperform in the future. Here's what I was told: "Identifying which active managers are likely to beat their respective benchmark going forward is the $64,000 question." Nevertheless, I was advised that Vanguard believes its due diligence and the lower cost of its actively managed funds give its funds an edge.
I am a proponent of low costs, but a closer look at the data indicates that predicting which of Vanguard's actively managed funds is likely to outperform is impossible because it is random. I took the ten year period used by Vanguard for its performance calculations and divided it into two five year periods. Here's what I found:
This data tells you the obvious: Past performance does not predict future performance. Vanguard agrees, noting that it "...believes that consistently outperforming the financial markets is extremely difficult."
If Vanguard can't pick actively managed funds with a consistent record of outperformance, what are the chances you and your broker will fare any better? Vanguard investors who have $750 billion invested in its actively managed funds would most likely achieve higher returns if they transferred those assets into a globally diversified portfolio of its low management fee index funds.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.
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Fool.com: Mutual Funds -- Basics -- How to Choose a Mutual Fund
Investing in Actively-Managed Funds
How to Choose a fund - Mutual Funds Center - Yahoo! Finance
If Index Funds Perform Better, Why Are Actively Managed Funds More ...
Index Funds vs. Actively Managed Funds: Which Are Best? - ABC News
Investing In Actively Managed Funds: Deal or No Deal? » My Money Blog
https://personal.vanguard.com/us/insights/article/fund-announcement-06142011
Continued expansion of the dark side of the force.
I recently read a book where the author published two Stock Charts, one was totally made up from random numbers generated from a computer, the other was for INTEL. He showed the charts to a dozen professional investors..none of them were able to spot one as being a fake, they all had complicated explanations on what was going on and several ever suggested when it happened..
Charts are usefull, but lousy long term predictors...
The entire industry is a shell game, now Vanguard is the most reasonable but that is like saying is it the least offensive garbage can.
I thought some talented people like Warren Buffet know what stocks to pick and when to buy them and what stops to dump and when to dump them to make money. So why do indexing? If the index tanks your investment will tank and if the index goes up so does your investment. It seems that in the long run your investment will simply be treading water.
Warren Buffet even recommends index funds. What you don't seem to realize is that if the index tanks, your actively managed, expensive fund can tank even more than the benchmark index.
That coupled with the fact that the most highly educated, highly skilled, plugged in traders can't beat the benchmark indexes most of the time should tell you everything you need to know.
The thing is that even if SSPs existed they would be irrelevant. Let's say you really managed to capture the Unicorn. You have found somebody who is genuinely smarter than everybody out there. Your very own SSP looks at a stock trading at $45 and sees that it should be trading at $65. So you buy it. And it stays at $45! The problem is that even though your SSP knows that the stock should be $65 everybody else still is thinking $45 and so that is where the price will stay!
I doubt very many average Americans were ever that interested in becoming their own financial planners as far as their retirement savings is concerned.
while you are buying shares. The whole point behind Treynor-Black is that you purchase an overweight/underweight amount of share X relative to its benchmark share and over the long run the share price reverts to equilibrium as new information is discovered, producing alpha.
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I hope your writings will be read and taken to heart by everyone.
Please, keep up the great and important work you are doing here!
Sincerely,
Garry Kanter
You know we need actively managed portfolios. Indexing would not work without them. Grossman Stiglitz Paradox.