How to select an actively managed fund


Vanguard investing experts Dan Newhall and Daniel Wallick discuss the factors an investor should consider when selecting an actively managed fund.

Notes:
All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor.
© 2016 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.  


TRANSCRIPT

 
Jon Cleborne: So we do have a live question that’s come in, and it’s along these same lines. So Greg asks, “If index funds are outperforming 80% of actively managed funds, why would anybody want to own an actively managed fund?” I think that’s a reasonable question to ask in this space. It is really hard to do this well. So maybe, Dan, I’ll throw it to you on that one.

Dan Newhall: Well, and it’s true that the majority of active funds, actively managed funds underperform net of their expense ratio. So we’ve talked a lot already about the importance of having a lower hurdle to success. And so the lower the cost, you’re shifting the odds a little bit better. I mean the market is a zero sum game. Without any costs, 50% of investors will outperform. In a given period of time, 50% will underperform. Net of cost, it’s close to those statistics that the majority will underperform. So it’s rational to say, “Well, why would you do it?” You know, in my mind, the why is that there is some percentage of fund managers who can outperform. And to the extent you outperform, there can be a material benefit. And you can outperform, in our estimation, by having lower cost, being incredibly careful about who you hand your money to, to run it on an actively managed basis, and being incredibly patient with the results of that. So we think that, yes, the odds are against the average investor; the odds are against the average fund manager of success. You could say, “Alright, let’s keep it simple. Just index it for that reason.” I think that’s very persuasive, actually, in many cases. But if you had an appetite to try to do better and/or you perceive additional benefits of active management in terms of risk control perhaps or additional diversification, you know, if you’re careful about the type of fund you invest in, contain the costs, partner with a world class manager—and that’s what I spend my life helping Vanguard investors do is picking among the world’s best managers—you can have great results. And Vanguard has managed to do it. There’s no guarantee of it. It’s not every year. It can be challenging. It requires patience. But that’s, you know, what we think we’re doing on behalf of investors is trying to tilt those odds back in their favor.

Daniel Wallick: You know, Jon, I have a chart that might actually help this, right? Dan spends his day finding great managers. I spend my life making charts and writing papers. So if we could pull up the zero sum chart, that might be a good visualization of what we’re talking about. And the point about this chart, and Dan was alluding to this, is that what the zero sum chart suggests, right, is that the market cap is the weighted performance of everybody involved, and half the assets are going to outperform and half the assets are going to underperform.

Jon Cleborne: That’s the nature of the average. If the benchmark and the index product is the average, it’s going to be right in the middle of that distribution.

Daniel Wallick: Correct. And what that chart suggests is, you know, if you’re high on that chart, that means there’s more dollars and securities in that one point. But the key point of clarification here: Sometimes we talk about outperformance and we count the number of funds that do that. This chart is suggesting, on an asset-weighted basis, if you dollar-weight the performance, the theory would suggest you’re going to get 50% outperformance and 50% underperformance. And the other thing that’s going to impact that is cost, as we talked about before. Cost is going to move that center line left or right, depending on how expensive everything is. So the two things that really matter, thinking about it on an asset-weighted basis? On an asset-weighted basis, the probability of performance is actually closer to 50/50 than on a count basis. So rather than identifying each fund as an individual choice, if you weight the funds, that’s different. And then cost is going to be a really big impact on that.

Important information
All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor.
© 2016 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.