Active mutual funds get a bad rap. Although, some of that criticism is well deserved. The truth is most active managers fail to beat their benchmarks and chronically underperform. Because of this, many investors have turned to index investing and ETFs to get their market fix.
The reason for so much indexing love, and perhaps the cause of why active mutual funds tend to fail, comes down to cost.
Active funds generally cost more than their cheap indexing rivals. Those higher costs are a hurdle that managers must clear before they can tack on any gains. Think about it. An active mutual fund with an expense ratio of 1.25% needs to make that 1.25% first, before it can chase its benchmark. With ETFs charging just 0.03% these days, the ball is in their court.
But here’s the thing — not all active mutual funds are bad. In fact, many can and do clear their higher fee hurdles, offer higher active shares and actually *gasp* beat their beat their benchmarks over time. It’s here that investors can get higher returns. Adding a smattering of these active funds to a cheap indexed core portfolio can do wonders.
With that, here are five active mutual funds worthy of their expenses.
T. Rowe Price QM U.S. Small-Cap Growth Equity (PRDSX)
Expense Ratio: 0.79% or $79 per $10,000 invested.
Minimum Investment: $2,500
One of the best places to find active mutual funds worth owning is in the small- and mid-cap spaces. In this market cap size, there’s more chance to values and great growth stories as Wall Street analysts tend to ignore smaller stocks. And that’s just what the T. Rowe Price QM U.S. Small-Cap Growth Equity (MUTF:PRDSX) has been doing since the late 1990s. It looks like one of the best funds in its niche.
Fund manager Sudhir Nanda combs through the broader small-cap world by using screens tied to valuation, quality and momentum. Those stocks that meet the standards are included in the portfolio’s holdings. Right now, that’s 300 stocks, including EXACT Sciences Corporation (NASDAQ:EXAS) and Fair Isaac (NASDAQ:FICO). However, no stock makes up more than around 1.25% of PRDSX’s portfolio.
The best part is that Nanda and his screens have made PRDSX a top performer.
Since 2006 when Nanda became the head manager, PRDSX has managed to beat the S&P 500 by an average 2.7 percentage points a year. Moreover, when looking at its benchmark- the MSCI US Small Cap Growth Index- PRDSX has beaten it over the one-, three-, five- and 10-year periods. And pretty significantly at that.
Nanda and his team at PRDSX are clearly adding value for investors and are worth the active mutual funds’ 0.79% expense ratio.
Fidelity Focused Stock (FTQGX)
Expense Ratio: 0.82%
Minimum Investment: None
One of the best parts about index investing is the diversification involved. So, you want your active fund to perform differently than an index, it can’t look like an index. One of the other great ways to beat the market is by concentrating your picks. So-called high-conviction funds only hold a handful of stocks that the managers believe will provide great returns. Instead of 500 stocks, you only get 40. And in that, you get better returns.
The Fidelity Focused Stock (MUTF:FTQGX) is one of the best funds at turning concentrated bets into bigger gains.
As the name implies, FTQGX is focused on a few stocks. In this case, the active mutual fund will own between 30 and 80 different names. These can be either growth or value stocks that the managers think will outperform over the longer haul. Lately, the active mutual fund’s focus has been on growth names, holding only 38 stocks. Healthcare and technology stocks dominate the mutual fund’s top holdings. These include Amazon (NASDAQ:AMZN) and AstraZeneca (NYSE:AZN).
The fund’s results prove that it’s high-conviction strategy is a winner.
FTQGX has crushed the S&P 500 over its life. The fund has managed to beat the broader index over the 3-, 5- and 10-year periods. Perhaps the biggest win for the mutual fund came last year. As the S&P lost money, the Fidelity Focused Stock mutual fund managed to produce a positive 5.32% return.
When it comes to active mutual funds, FTQGX is one of the best funds to buy.
Vanguard International Growth Fund Investor Shares (VWIGX)
Expense Ratio: 0.45%
Minimum Investment: $3,000
Vanguard is the king of indexing. But the asset manager is pretty good when it comes to active mutual funds as well. A prime example is the Vanguard International Growth Fund Investor Shares (MUTF:VWIGX).
International stocks have been a mixed bag since the recession. Like U.S. stocks in the previous decade — marked by the dot com crash and great recession — international equities are nearing a so-called lost decade of performance. Indexing in the stocks of Europe, Japan and other developed markets would have netted you basically nothing. Active managers, however, have done much better. VWIGX over the past 10 years, managed to return an average annual 9.52%. That’s nearly double its benchmark — the MSCI World ex-USA Index.
VWIGX’s excess return comes from its strategy.
The fund is dually managed by Baillie Gifford Overseas and Schroder Investment Management at roughly a 60/40 spilt. Baillie Gifford runs a more traditional growth sleeve for its assets. This means paying for stocks that are rapidly growing sales. This has it diving head-first into emerging markets and international tech firms. Schroder’s is more of value seeker and uses growth-at-a-reasonable price, or GARP, investing strategy to find bargains. The combination provides fast growth with some stability. That allows for less volatility and overall better returns.
And with a Vanguard-low expense ratio, investors are able to keep more of those returns — even for this actively managed mutual fund.
Metropolitan West Total Return Bond (MWTRX)
Expense Ratio: 0.67%
Minimum Investment: $5,000
Bonds and fixed-income investments tend to be another area that active mutual funds can outperform their indexes. That’s because many bond indices are rigid in their construction and/or are weighted on the amount of debt. Total return or go-anywhere bond funds allow their mangers to buy what they view is a best bet at the time. Because of that, top active managers in the fixed income space can and do earn returns above their benchmark indexes.
That includes the Metropolitan West Total Return Bond (MUTF:MWTRX).
The $71 billion behemoth is surprisingly nimble for a bond fund and can really go anywhere to find a good total return — that is price appreciation and dividends. According to its mandate, the mangers at MWTRX can own corporate bonds, collateralized debt obligations, mortgage-related and asset-backed securities, bank loans, money-market securities, swaps, futures, municipal securities, options, credit default swaps, private placements and restricted securities. And it doesn’t matter if they have interest rates that are fixed, variable or floating. It really can own it all.
And owning it all has been a great strategy.
MWTRX has managed to crush its benchmark — the Bloomberg Barclays U.S. Aggregate Bond Index- by a mile. Over the last 10-years, the active mutual fund has returned 5.51% annualized. This is versus just a 3.48% annualized return for the index. No wonder why the fund has a four-star rating and a Gold recommendation from Morningstar.
Matthews Pacific Tiger Fund (MAPTX)
Expense Ratio: 1.08%
Minimum Investment: $2,500
Emerging markets hold plenty of promise and those in Asia are particularly primed for growth. However, how do you know which is a good nation or bad, or which stocks can capitalize the best to take advantage of the potential. Separating the wheat from the chaff takes an active touch and a real boots on the ground approach.
That’s exactly what the Matthews Pacific Tiger Fund (MUTF:MAPTX) does.
Matthews Asia only does Asian-focused mutual funds and separate managed accounts. This expertise has allowed the firm to before better than many of its benchmarks and indexes. This includes MAPTX — one of its flagship funds.
MAPTX bets on stocks in countries and markets in Asia, including developed, emerging, and frontier countries but excluding Japan. However, the bulk of the fund’s holdings lie within developing and emerging markets. Sure, China is included … but so is Thailand, Malaysia and Indonesia. This different concentration as well as the fact that the fund only holds about 60 stocks has allowed MAPTX beat its benchmark — the MSCI All Country Asia ex Japan Index — over the long haul. Over the last 5- and 10-year periods, MAPTX has beaten the index by roughly 1.5 percentage points per year. Since its inception in 1994, it’s more than doubled its performance.
Clearly, Matthews has the winning formula in its specialty and has managed to clear its expense ratio hurdle with ease.
At the time of writing, Aaron Levitt did not have a position in any of the active mutual funds mentioned.
