Article on Active Vanguard funds outdid Index - Thoughts?

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jonny781
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Article on Active Vanguard funds outdid Index - Thoughts?

Post by jonny781 »

I was just reading this article and wondering what people's thoughts were:

http://www.thestreet.com/story/11851049 ... marks.html

It basically discusses how Vanguard's active managed funds have outperformed the index funds over the past 30 years (especially the last 10 years). What are people's thoughts when they read articles like this? Are there fallacies in this argument?
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G-Money
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Re: Article on Active Vanguard funds outdid Index - Thoughts

Post by G-Money »

Prior thread on what I believe is the paper referenced in the article: http://www.bogleheads.org/forum/viewtop ... 0&t=110185

My thoughts are mostly that costs matter. Vanguard does a good job of keeping costs low for both their active and passive funds. If you keep active funds' ERs close to those of index funds, their performance should, on average, be identical. Tracking error of 0.79%, (assuming no style drift), though it can add up to a lot, isn't shocking.

I'm sticking with index funds.
Last edited by G-Money on Tue Jun 18, 2013 3:09 pm, edited 1 time in total.
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fishndoc
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Re: Article on Active Vanguard funds outdid Index - Thoughts

Post by fishndoc »

Two thoughts:
1. It is not so much that index funds outperform active funds, it is that low cost, low turnover funds outperform high cost funds. Most Vanguard active funds are fairly low cost.
2. Past performance does not predict future returns. I will stick with my core of super-low cost index funds, and not lose sleep about the small possibility that I might have earned a fraction of a percentage more by taking on the added risk of active management.
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Re: Article on Active Vanguard funds outdid Index - Thoughts

Post by nisiprius »

1) If they hadn't, would he still have written the article?

2) Is he talking about risk-adjusted return? That's often the phonus-balonus when someone says that an active fund outperformed. And is he comparing to appropriate benchmarks? The fact that he doesn't even mention either of these things suggests he's not even worth paying attention to. But, let me take the bait and check out one of his comparisons.

Vanguard Capital Value fund, for example. He says "Among the star performers was Vanguard Capital Value (VCVLX), a large blend fund that returned 9.6% annually during the past decade, compared to a return of 8.0% for Vanguard 500 Index (VFINX), according to Morningstar." Well, yeah, but look at how they did during 2008-2009. Isn't it obvious that the Capital Value fund dropped much further... and is generally more volatile, bigger fluctuations all along? More risk.

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Morningstar is showing a 10-year standard deviation of 21.67 for VCVLX, 14.56 for the VFINX. VCVLX fluctuates almost half again as much as VFINX, it's almost 50% "riskier."

Well, is that risk justified by extra return? The Sharpe ratio says no, 0.45 for VFINX, only 0.42 for VCVLX. Forget future results, the past results show that just on the basis of past performance VCVLX did not do as well as VFINX if you adjust for risk. Really the difference is razor-thin and there are probably periods of time over which it went the other way, but the point is that it is nonsense to talk about VCVLX as outperforming VFINX.

There is nothing that VCVLX did that you couldn't have done just as well simply by increasing your allocation of VFINX.

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Re: Article on Active Vanguard funds outdid Index - Thoughts

Post by grabiner »

There may also be some survivorship bias at work; Vanguard once had a technology fund, but closed it before the Internet bubble. Funds which Vanguard took over also have a survivorship bias, as Vanguard inherited their pre-Vanguard performance.

I'll do a quick check for all funds which have a 10-year record, Investor class only.

LV: 3 of 3 beat Value Index (US Value, which lost, was not a Vanguard fund for the whole period)
LB: 0 of 1 beat 500 Index (Dividend Growth, which won, was a utilities fund for part of the period)
LG: 2 of 4 beat Growth Index (Growth Equity, which lost, was not a Vanguard fund for the whole period)
MV: 0 of 2 beat Russell Mid-Cap Value Index (which is Selected Value's benchmark)
MB: 0 of 1 beat Mid-Cap Index
MG: 2 of 2 beat Russell Mid-Cap Growth Index after adjusting for expenses
SV: No fund with 10-year record
SB: No fund with 10-year record
SG: 0 of 1 beat Small-Cap Growth Index
Global: 1 of 1 beat its benchmark (Global Equity versus weighted index)
LC International: 2 of 2 beat Total International
SC International: No fund with 10-year record (International Explorer was not a Vanguard fund for the whole period)

Total: 7 of 14 US, 3 of 3 international, beat the index. Vanguard's active funds have low costs and consistent investment philosophies, so you would expect them to do about as well as their benchmarks, and 10 of 17 is a reasonable expectation.

It's also notable that none of the funds were way off from the benchmark. Capital Value is the only fund which underpeformed by 2% over 10 years (and that may be relative to the wrong benchmark; Vanguard benchmarks it against the Russell 3000 Value rather than the mid-cap value index), and PRIMECAP the only fund which outperformed by 2%.
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Re: Article on Active Vanguard funds outdid Index - Thoughts

Post by jeffyscott »

As the article states:
The biggest single reason is low fees. Vanguard's active equity funds charge average expense ratios of 0.37%, compared to 1.29% for the average domestic equity fund.
Fund managers can add value, they just don't add enough value to overcome the typical expense ratio. Vanguard active fund managers do not have to add much value to overcome their fund costs.
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Re: Article on Active Vanguard funds outdid Index - Thoughts

Post by nedsaid »

During the 2000's value outperformed growth after the opposite happened in the 1990's. That might be all that happened.

For those of us who believe in the value premium, this looks like the value premium at work.
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Re: Article on Active Vanguard funds outdid Index - Thoughts

Post by SimpleGift »

jonny781 wrote:It basically discusses how Vanguard's active managed funds have outperformed the index funds over the past 30 years (especially the last 10 years). What are people's thoughts when they read articles like this? Are there fallacies in this argument?
As a taxable investor, the biggest shortcoming I see when reading an article like this is that it emphasizes only pre-tax performance. Sure, pre-tax, 63% of Vanguard's active equity funds outperformed their benchmarks (see table below, from the original report). However, after-tax, only 38% outperformed, with a median excess return of -0.54% per year.

Vanguard may have many enticing active equity funds due to their low costs, but their tax efficiency is usually just as bad as other active funds — which is why Vanguard's comparable equity index funds are almost always a much better option in a taxable account.

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Source: The Case for Vanguard Active Management
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Re: Article on Active Vanguard funds outdid Index - Thoughts

Post by nisiprius »

grabiner wrote:There may also be some survivorship bias at work; Vanguard once had a technology fund, but closed it before the Internet bubble. Funds which Vanguard took over also have a survivorship bias, as Vanguard inherited their pre-Vanguard performance.

I'll do a quick check for all funds which have a 10-year record, Investor class only.

LV: 3 of 3 beat Value Index (US Value, which lost, was not a Vanguard fund for the whole period)
LB: 0 of 1 beat 500 Index (Dividend Growth, which won, was a utilities fund for part of the period)
LG: 2 of 4 beat Growth Index (Growth Equity, which lost, was not a Vanguard fund for the whole period)
MV: 0 of 2 beat Russell Mid-Cap Value Index (which is Selected Value's benchmark)
MB: 0 of 1 beat Mid-Cap Index
MG: 2 of 2 beat Russell Mid-Cap Growth Index after adjusting for expenses
SV: No fund with 10-year record
SB: No fund with 10-year record
SG: 0 of 1 beat Small-Cap Growth Index
Global: 1 of 1 beat its benchmark (Global Equity versus weighted index)
LC International: 2 of 2 beat Total International
SC International: No fund with 10-year record (International Explorer was not a Vanguard fund for the whole period)

Total: 7 of 14 US, 3 of 3 international, beat the index. Vanguard's active funds have low costs and consistent investment philosophies, so you would expect them to do about as well as their benchmarks, and 10 of 17 is a reasonable expectation.

It's also notable that none of the funds were way off from the benchmark. Capital Value is the only fund which underpeformed by 2% over 10 years (and that may be relative to the wrong benchmark; Vanguard benchmarks it against the Russell 3000 Value rather than the mid-cap value index), and PRIMECAP the only fund which outperformed by 2%.
+1

But of course, I want more! more! I'm always yammering about "magnitude, not just direction," and counts of how many funds "beat" something aren't very meaningful without knowing "by how much." So if you still have the data handy... here's a stupid metric but less stupid than a count, or feel free to substitute something smarter...

How did an equal-weighted, un-rebalanced portfolio of the active funds that had ten-year records perform relative to an equal-weighted, un-rebalanced portfolio of their indexes? I'd bet a nickel, even money, that the difference is measured in basis points and not very many of them, but...
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Re: Article on Active Vanguard funds outdid Index - Thoughts

Post by IlliniDave »

fishndoc wrote:Two thoughts:
1. It is not so much that index funds outperform active funds, it is that low cost, low turnover funds outperform high cost funds. Most Vanguard active funds are fairly low cost.
2. Past performance does not predict future returns. I will stick with my core of super-low cost index funds, and not lose sleep about the small possibility that I might have earned a fraction of a percentage more by taking on the added risk of active management.
Item 1) I think is the key. There's also perhaps some semantics. My way of thinking about it is there's Index funds and non-Index funds. That's a question of how the portfolio was selected. Then there's active-style managed funds and passive-style managed funds. Index funds are passive-style managed almost by definition. Non-index funds can be managed either active-style or passive-style. Vanguard non-Index funds seem to be largely managed passive style. Sometimes I've heard these called "virtual Index funds".

An example I'm familiar with it VHCOX (Vanguard Capital Opportunity Fund) the most recent numbers I've seen state an annual turnover below 9%, which rivals that of index funds.

Item 2) is important too. I think I read the source article on VG and much like different indexes relative to each other, there seems to be ongoing reversion to the mean between the active and passive funds, so I'm not sure looking ahead for a given time span whether the indexes will beat the "virtual indexes" or not. In the end I didn't come away from the VG paper convinced there was a decided advantage to VGs non-index funds. Maybe I need to review it a little more carefully.

My core is index funds, but much like chili peppers in food, I like to add a dash of well-chosen (hopefully well-chosen) passive-style managed non-Index funds.
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jonny781
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Re: Article on Active Vanguard funds outdid Index - Thoughts

Post by jonny781 »

I just want to say I'm completely new to this forum but this is an amazing community. To be able to make a post like this and get so much valuable feedback and opinions on the matter is great.
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Re: Article on Active Vanguard funds outdid Index - Thoughts

Post by grabiner »

nisiprius wrote:But of course, I want more! more! I'm always yammering about "magnitude, not just direction," and counts of how many funds "beat" something aren't very meaningful without knowing "by how much." So if you still have the data handy... here's a stupid metric but less stupid than a count, or feel free to substitute something smarter...
As you requested. Investor classes used for all funds; if the index fund doesn't have a 10-year history, the benchmark index minus 0.25% is used as the reference. All data is from Vanguard, for ten years ending 5/31/13.

Equity Income: +1.08%
Windsor: -0.23% (was incorrectly identified as a winner in previous post)
Windsor II: +0.36%
Growth&Income: -0.39%
Morgan Growth: +0.16%
(FTSE Social Index was included by mistake in previous post)
PRIMECAP: +2.65%
US Growth: -1.07%
Capital Value: -2.04%
Selected Value: -0.21%
Strategic Equity: -1.09%
Capital Opportunity: +1.49%
Mid-Cap Growth: +0.24%
Explorer: -1.92%
Global Equity: +1.21%
International Growth: +0.47%
International Value: +0.51%

Average of all 16 funds: +0.08%

One fund wins by more than 2%, three win by 1-2%, five win by 0-1%, three lose by 0-1%, three lose by 1-2%, and one loses by more than 2%.
How did an equal-weighted, un-rebalanced portfolio of the active funds that had ten-year records perform relative to an equal-weighted, un-rebalanced portfolio of their indexes? I'd bet a nickel, even money, that the difference is measured in basis points and not very many of them, but...
You win that nickel; the +0.08% could easily become somewhat higher or negative if a different benchmark were chosen (for example, using Total Stock Market or all-cap Russell indexes rather than Growth/500/Value Index for the large-cap funds would raise the index returns, while using a different mid-cap index would lower them).
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