8
Recently on Morningstar.com, I asked, do active funds
have a future? Several readers found that to be a silly
question. There are good funds of each flavor, they
argued. Rather than pit active funds against passive
funds, I should distinguish between deserving funds
and those that are not. I agree.
That column discussed what is, not what should be.
And what is, is a public-relations thrashing. Index-
fund managers have convinced the marketplace
that the critical investment issue is whether to be
passive or active. The triumph of indexing has
become a familiar tale, detailed not only in
The Wall
Street Journal
’s recent feature on Vanguard but
also again days later in Jason Zweig’s column. Active
management is regarded as a loser’s game.
That belief, however, is incomplete. It’s true that
active management sold at its customarily steep price
is second-rate. But so are high-cost index funds.
How a fund is managed is less important than its
cost headwind.
To test the proposition, I sorted active U.S. diversified-
stock funds into two groups: the very cheap and the
expensive. Funds in the first group have current
annual expense ratios of no more than
0
.
50%
, while
those in the second have expense ratios of at least
1
.
50%
. Several of the discount funds were offered by
Vanguard; I set those aside into a new pool to be
measured separately. Finally, I discarded
DFA
’s funds.
They appear in Morningstar’s database as active
funds, because they must be
somewhere
, but in
reality they straddle a middle ground. They do
not belong with active funds for the purpose of this
test. That made for three comparison groups for
active funds:
1
)
Vanguard,
2
)
not from Vanguard but
priced like Vanguard, and
3
)
expensive. To those
three groups, I added a fourth group of Vanguard
index funds. I then calculated the average total-
return rank for each group, as compared against other
funds of the same category, over the trailing
15
years.
Vanguard’s actively run funds have outperformed their
more-famous index siblings. The very cheap active
funds from other companies were somewhat behind
Vanguard’s active offerings but were fully competi-
tive with the company’s index funds. The costly funds
lagged significantly, as expected.
The index funds’ average ranking of
44
may strike you
as unimpressive. If so, that is partially because you
have been oversold by index marketers, who like to
imply that actively run funds outgain indexes over
the long term as often as metal scavengers find long-
forgotten gold hoards. The occasion is not nearly so
rare. But there is also a legitimate explanation: Every
Vanguard index fund from
15
years ago exists today,
where as many losing competitors closed their doors
and thus do not appear in this study. Vanguard’s
index funds compete against the winners.
This includes Vanguard’s active funds, several of
which were merged or liquidated during the period.
Thus, I hesitate to declare victory in this contest
for either Vanguard’s group of active funds or for the
larger pool of non-Vanguard funds. While some
active fund families rarely if ever kill their babies (for
example, American Funds), the practice is prevalent
enough such that one must be wary when comparing
live funds against live funds. Nonetheless, even
Active Versus Passive
Is the Wrong Question
Morningstar Research
|
John Rekenthaler
33
43 44
60
U.S. Diversified Stock Funds
15-Yr Category Ranking, by Total Return
70
60
50
40
30
20
10
Vanguard
Active
Data through July 31, 2014. Source: Morningstar Data.
Other Cheap
Active
Vanguard
Passive
Expensive
Active
