Factors to consider before adding actively managed funds to your portfolio

Hugh Watters, product manager in Vanguard’s Portfolio Review Department, explains the “talent, cost, and patience” factors that investors should consider before deciding to add actively managed funds to their portfolio.


Emily Farrell: James asked us, “So how do you choose an active fund that may outperform a comparable index fund?” So that really kind of gets to the heart of it.

Daniel Wallick:
There you go, performance and how to identify it.

Emily Farrell: Hugh, you want to kick it off?

Hugh Watters: Yeah, sure. So we, obviously, have a long history of offering active funds; and the three key factors that we have found are talent, cost, and patience. So in talent, we’re very qualitatively driven, so what we focus on, the firm, the people, the philosophy, the process. That helps us identify what I’ll say world-class managers.

Cost, we’ve talked about this, but that is the leading indicator to outperformance longer term. Right, so the higher the cost, the higher the hurdle for outperformance.

And then patience. We alluded to this a little bit with some of the studies we were talking about, but active management will be lumpy. We call it the bumpy road to outperformance. So you need to have patience to really unlock that active management, and I think some of the stats, obviously, we’ve thrown around. So the talent, the cost, and the patience are really the three key aspects to identifying successful, long-term active managers.

Emily Farrell: Yeah, I mean it seems fairly straightforward; and we know it’s not always easy, and that’s why your group spends their time thinking through those things every day. And you and your team of researchers have been looking at this for years. That long-term piece too. I mean you even challenged our question to the extent from 10 to 15 years as well.

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