Is Vanguard's Best Performing Fund An Index Fund?

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Includes: POGRX, POSKX, VASVX, VB, VDIGX, VEIRX, VEXAX, VEXRX, VFIAX, VHCAX, VIGAX, VIMAX, VLCAX, VMRAX, VOO, VPCCX, VPMAX, VSMAX, VTCLX, VTI, VTMSX, VTSAX, VUG, VV, VWUAX, VXF
by: Chris Wiesehan, CFA

Summary

Low fee index funds, particularly those from Vanguard, have become very popular as a simple way to invest and outperform most actively managed funds.

This article examines the performance of the top performing funds from Vanguard over the past 10 years.

Funds that were removed from the list were industry specific funds (healthcare, technology, etc.), geography specific funds (emerging markets, etc.), and bond funds.

Vanguard has a number of successful actively managed funds that have outperformed some or all of their index funds.

In particular, the series of Vanguard funds sub-advised by Primecap appears to have had the most success outperforming the index funds.

With all of the talk of investors shifting their money into cheap passively managed index funds, particularly those from Vanguard, I thought it might be interesting to ask the question...is Vanguard's best fund an index fund? Although most people know Vanguard for their index funds, they do have a handful of funds that are actively managed. Actively managed funds tend to have higher fees (eg. expense ratios) associated with them that are used to pay a team of people to pick the stocks that go into the fund. The prevailing thought nowadays is that those additional fees outweigh any benefits from active management and that cheap passively managed index funds will outperform their active counterparts over the long term.

Vanguard Funds we will eliminate from our list

First, let's rule out specific funds from Vanguard that are heavily concentrated in certain parts of the market and act more as satellite holdings in a portfolio as opposed to core U.S. stock holdings. These funds that we will eliminate from our list would be specific industry funds (mutual funds focused on a specific industry such as healthcare stocks, technology stocks, industrial stocks, etc.) and we will also throw out funds from Vanguard that have a majority of their holdings in specific geographies outside of the U.S. such as emerging markets. We will remove bond funds too. The reason for removing all of these funds is that we will assume that most investors would not put a large amount of their savings in a fund that is focused on one industry or one geography outside the U.S. So, as mentioned at the start of this paragraph, we are trying to find funds that might be a core holding in someone's portfolio.

We will use the 10 year return on the funds so that we will have a full market cycle. In other words, we want to have the financial crisis of 2008/2009 included in the analysis to see how the active funds and index funds have performed through a period that has had both good and bad times.

Notes

10 Year Annual Return (this is the return per year over the 10 year period)

Net of fees (returns will be net of expenses and assuming capital gains and dividends are reinvested in the fund)

8/31/2017 (the ending date, we will go back in time from here)

Vanguard's Website (this is where the data was collected)

Please note that some of the Vanguard funds offered the Admiral share class while others did not. The Admiral share class has a lower expense ratio than the Investor share class but requires you to make the initial purchase in bulk (there may be a +/-$50,000 minimum initial purchase, for investors who cannot afford the Admiral share class look for the Investor share class from Vanguard), the difference in return per year between using the Admiral share class and the Investor share class was typically about 0.10% to 0.20%.

The list, which is broken into three groups and ranked in order from highest return per year over 10 years to the lowest return per year over 10 years, is below. You'll see the name of the fund, the ticker symbol of the mutual fund, the ticker symbol of the ETF (if an ETF version exists), the 10 year return per year, and parenthesis indicating whether the fund is an active fund or an index fund. Please be aware that this is not all funds offered by Vanguard and I arbitrarily chose to end the list when I reached the Vanguard S&P 500 Index Fund, it has the lowest return on this list). A further level of analysis might have been to look at how many actively managed Vanguard funds are able to outperform their benchmark and how many are not able to (perhaps I'll write about this in a future article).

Large Cap Funds (large companies based in the U.S.)

  • Vanguard Primecap Admiral Shares (MUTF:VPMAX) - 10.23% (active)
  • Vanguard Primecap Core (MUTF:VPCCX) - 9.95% (active)
  • Vanguard Growth Index Admiral Shares (MUTF:VIGAX) (NYSEARCA:VUG) - 9.19% (index)
  • Vanguard U.S. Growth Admiral Shares (MUTF:VWUAX) - 8.79% (active)
  • Vanguard Dividend Growth (MUTF:VDIGX) - 8.38% (active)
  • Vanguard Morgan Growth Admiral Shares (MUTF:VMRAX) - 8.19% (active)
  • Vanguard Tax Managed Capital Appreciation Admiral Shares (MUTF:VTCLX) - 7.87% (index oriented but screens out stocks with high dividends)
  • Vanguard Equity Income Admiral Shares (MUTF:VEIRX) - 7.82% (active)
  • Vanguard Total Stock Market Index Admiral Shares (MUTF:VTSAX) (NYSEARCA:VTI) - 7.81% (index)
  • Vanguard Large Cap Index Admiral Shares (MUTF:VLCAX) (NYSEARCA:VV) - 7.73% (index)
  • Vanguard S&P 500 Admiral Shares (MUTF:VFIAX) (NYSEARCA:VOO) - 7.60% (index)

Mid Cap Funds (mid sized companies based in the U.S.)

  • Vanguard Capital Opportunity (Primecap) (MUTF:VHCAX) - 9.85% (active)
  • Vanguard Extended Market Index Admiral Shares (MUTF:VEXAX) (NYSEARCA:VXF) - 8.19% (index)
  • Vanguard Selected Value (MUTF:VASVX) - 8.09% (active)
  • Vanguard Mid Cap Index Admiral Shares (MUTF:VIMAX) - 8.01% (index)

Small Cap Funds (small companies based in the U.S.)

  • Vanguard Tax Managed Small Cap Admiral Shares (MUTF:VTMSX) - 8.64% (index oriented but screens out stocks with high dividends)
  • Vanguard Small Cap Index Admiral Shares (MUTF:VSMAX) (NYSEARCA:VB) - 8.35% (index)
  • Vanguard Explorer Admiral Shares (MUTF:VEXRX) - 7.71% (active)

Analysis of the data

You'll notice looking at the results that the two top large cap funds and the top mid cap fund are all actively managed funds that are sub-advised by Primecap. What does it mean when a fund has a sub-advisor? This is when a mutual fund company uses an outside firm to pick stocks and manage the portfolio. In other words, Vanguard is focused on initially creating the fund and selling it but the actual stock picking is done by an outside firm, in this case, Primecap.

The clear winner at Vanguard appears to be the actively managed funds managed by Primecap. You're probably now thinking that you're going to switch out your Vanguard index funds for Vanguard's Primecap funds. Not so fast...these funds are closed to new investment. In other words, if you don't currently own the fund or if you aren't going to put $1,000,000 with Vanguard (which would qualify you for Vanguard Flagship Services) then you can't buy any of them. Additionally, those investors that already have money in Vanguard Primecap or have access to Flagship Services can only add an additional $25,000 per year.

Who are the people behind Primecap

In January of 2015 Kiplinger did a nice article giving some background on the Primecap team.

How can you get access to Primecap?

Unfortunately you can't easily get access to the Primecap team through Vanguard, however, there is a workaround for this. Primecap does have two funds that are still open and managed in-house. These funds are the Primecap Odyssey Stock Fund (MUTF:POSKX) and Primecap Odyssey Growth Fund (MUTF:POGRX). Although the holdings aren't identical, Primecap Odyssey Stock has a 0.99 correlation with Vanguard Primecap Core over the past 10 years and Primecap Odyssey Growth has a 0.96 correlation with Vanguard Primecap over the past 10 years. These correlations are very high and indicate that the portfolios, historically, have been managed in a very similar fashion.

Conclusion

While much of the media is touting Vanguard's index funds the results over the 10 year historic period that I utilized show that Vanguard's best funds are those that have been actively managed, particularly those funds managed by Primecap. Beyond Primecap there were many other funds shown in the lists above that are actively managed and also outperforming index funds over the long term. The challenge is finding good actively managed funds that are still open to new investment. Perhaps a strong argument for index investing is that even though there are some active managers who can outperform, the ability to invest in those funds tends to go to the biggest and most sophisticated clients on Wall Street. Additionally, while people might fear that they are giving up significant returns by using an index fund, in reality they are only giving up ~0-3% per year and that's assuming that the person picking the actively managed fund is smart enough to pick one that will beat the index in the future.

PS - Another great sub-adviser that Vanguard utilizes to manage some of its active funds is Wellington Management. Some of the top performing actively managed funds mentioned above are sub-advised by Wellington.

Disclosure: I am/we are long POGRX, VOO, VTI, VB, VO, VDIGX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.