by Dan Wiener | April 15, 2013 5:30 am
Is this as good as it gets?
At the beginning of this year, a Vanguard research report, The Case for Vanguard Active Management, was released. In it the company argues that active managers who run low-cost mutual funds can generate market-beating returns. You and I know that Vanguard has hired some superb active managers, but it begs the question: Do Vanguard’s in-house active stock managers live up to this claim of superiority?
In addition to managing all of the firm’s stock index strategies, Vanguard’s Equity Investment Group (formerly known as the Quantitative Equity Group) is responsible for actively managing $10 billion, at a minimum. Not exactly chump change. As the group’s previous name implies, they pick stocks quantitatively, or rather they let a computer do the picking for them.
The group manages at least portions of a number of funds including Vanguard Equity Income Fund (VEIPX), Vanguard Strategic Equity Fund (VSEQX), Vanguard Strategic SmallCap Equity Fund (VSTCX) and Vanguard Growth and Income Fund (VQNPX). But their longest-running (and cleanest) track record is on an institutional fund, Vanguard Structured LargeCap Equity Fund (VSLPX), where they have been the only manager since the fund’s January 2003 inception. The fund’s objective is to generate a “long-term total return higher than that of the S&P 500 Index, while maintaining a risk profile similar to the index.”
Trying to beat the S&P 500, Structured LargeCap Equity typically holds around 150 stocks, though the portfolio has ranged between 130 and 175 or so over the past decade. Sector weights are very similar to the index, and there is significant overlap in the top-10 positions (seven out of 10 were the same as of Dec. 31, 2012) with Vanguard 500 Index Fund (VFINX). Essentially, the computers are trying to pick the winners and avoid the losers in the S&P 500 while still looking a lot like the index.
Have they succeeded? Technically, the answer is yes, but it’s not a convincing victory. Investing in Structured LargeCap Equity at its inception would have turned $100 into $203. A similar investment in 500 Index would have yielded $202. As the chart below shows, at times each fund led in the performance derby, but more often than not, the two lines are indistinguishable.
The best thing you can say for the Equity Investment Group is that the computers overcame the slightly higher expense hurdle (0.24% vs. 0.17%), to match the index fund. Nothing over the past 10 years suggests the computers can consistently generate total returns above and beyond the index. I’d argue the odds are just as good in the future that the computers could misfire.
I agree with Vanguard that there are exceptional active managers who have proven capable of generating market-beating returns and can continue to do so. Names like Jim Barrow, the PRIMECAP Management team and Donald Kilbride come to mind. I’m not convinced Vanguard’s computers, and the folks who program them, are in that group of elite managers, however.
Senior Editor Dan Wiener and Editor/Research Director Jeffrey DeMaso publish The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of recent developments at Vanguard, and the annual FFSA Independent Guide to the Vanguard Funds.
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