Vanguard exchange-traded funds (ETFs) have become a juggernaut in the world of passive investment management. They are widely used across retail, institutional, and retirement plans as an effective way to get low-cost, liquid, tax efficient and dependable exposure to both stocks and bonds. You simply can’t go wrong when choosing one of their funds as a core or tactical holding within your ETF portfolio.
One of the keys to their success is the ability to classify an ETF as a separate share class of their existing mutual fund platform. This creates the benefit of a built-in track record and a comparative index from which to evaluate even newly established ETFs. Think of them as just porting the mutual fund strategy to a vehicle with lower costs that you can trade throughout the day.
While the Vanguard ETF business is an unqualified success, in my opinion, there is still room for growth into active Vanguard funds.
Yeah, I said it. Vanguard needs to port some of their active strategies to ETFs as well.
Many investors overlook the actively managed suite of Vanguard mutual funds because they don’t follow the traditional “high cost, weak performance” mantra that dogs other fund companies. They have partnered with world-class asset managers to keep fees low and successfully navigate the markets for their investors for decades.
Let’s hope Vanguard considers my wish list of active funds that would make great ETFs.
Active Vanguard Funds: Vanguard Wellesley Income Fund (VWIAX)
Click to Enlarge Vanguard Wellesley Income Fund (MUTF:VWIAX) takes a multi-asset approach to its portfolio construction methodology by owning 35-40% stocks and 60-65% bonds. This strategy is geared towards investors that want steady income and capital appreciation with a conservative mindset.
VWIAX has been managed by Wellington Management Company LLP for 40 years and has accumulated $50 billion in total fund assets. The fund managers own just 61 stocks that are primarily value-focused. This includes names like Microsoft Corporation (NASDAQ:MSFT) and Wells Fargo & Co (NYSE:WFC). They also balance that exposure with high quality Treasury and investment grade corporate bonds with an average duration of 6.4 years.
Furthermore, the fund charges an all-in expense ratio of just 0.15% annually. That is tremendously cheap compared to its peer group and it has posted very steady returns over its tenure as well. Vanguard lists the 10-year annualized return of VWIAX at 6.74% through Dec. 31, 2016.
I have owned VWIAX for clients of my wealth management firm for several years now because I have yet to come across a competitor that can offer similar or better qualities. The fund is cheap, its performance is outstanding, and it strikes just the right balance of risk and reward for more cautious investors.
Active Vanguard Funds: Vanguard PrimeCap Fund Admiral Shares (VPMAX)
Click to Enlarge Vanguard PrimeCap Fund Admiral Shares (MUTF:VPMAX) has the distinction of being in a select group of Vanguard mutual funds that are closed to new investors. Fund companies often employ this tactic if they feel the size of the fund will adversely affect the long-term strategy and don’t want it to become bigger than they can handle.
However, this one is definitely on my wish list for an ETF version.
This mutual fund invests in a diversified group of 130 large and mid-cap stocks that the manager feels offer superior growth potential. The hallmarks of the strategy are low turnover, low costs, and a long-term perspective. VPMAX charges an expense ratio of 0.33% and has demonstrated an impressive track record as well.
The fund has beat both the SPDR S&P 500 ETF (NYSEARCA:SPY) and Vanguard Total Stock Market ETF (NYSEARCA:VTI) over the last five years. The fund company website also lists the annualized 10-year performance at 9.41% annualized through Dec. 31. The fund has nearly $50 billion in total assets largely because of its superior performance story.
I know it’s a long shot, but this one would be an excellent actively managed U.S. equity ETF.
Active Vanguard Funds: Vanguard Strategic Equity Fund (VSEQX)
Click to Enlarge Vanguard Strategic Equity Fund (MUTF:VSEQX) is an actively managed stock mutual fund that focuses on small and mid-capitalization companies. The fund is managed by Vanguard’s own in-house Quantitative Equity Group.
The purpose of this fund is to select smaller, more aggressive stocks with the potential for outperformance versus the benchmark. Currently the fund owns 368 stocks and has $6.8 billion under management.
This type of strategy can be strategically paired with a traditional large-cap ETF or mutual fund to broaden your exposure to the domestic stock market. VSEQX only charges a modest expense ratio of 0.18% and has been a top-performer throughout its history.
Vanguard lists the 10-year track record of this fund at +10.82% annualized over the last ten years through Dec. 31. It also has managed to beat the Vanguard Extended Market ETF (NYSEARCA:VXF) quite handily over the last five years as well.
This type of low-cost, actively managed style would likely appeal to aggressive ETF investors that desire something more strategic than a typical index fund.
The Bottom Line
Porting a successful mutual fund to an exchange-traded fund does not guarantee instant victory. Vanguard has more than likely considered this path already and chosen to take their time getting there. They may also be wary of the greater maintenance in running an active strategy in the ETF wrapper with the constraints of daily liquidity and transparency.
There have not been many stock-only or multi-asset ETFs that have successfully made it as active ETFs. Nevertheless, if anyone can do it, I would put my money on Vanguard to strike the right balance of cost and strategic positioning.
David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. VWIAX is held long in client accounts. To get more investor insights from FMD Capital, visit their blog.