Surprise Performance: The Fund Giants Don't Always Win

By Tom Madell

I like broad index funds/ETFs, such as the Vanguard Total Stock Market Index Investor (VTSMX) (or higher minimum Admiral shares) and the SPDR S&P 500 ETF (SPY), and it appears that many investors agree; these two are among the funds with most investor assets. I like them, yes, but I can't say that I truly love them. Here's why.

Investors in such funds seem to have come to assume you can get as good or better results investing without a specific focus than if you opt for funds that can put you into stocks that may for the foreseeable future present somewhat more opportunity. For example, Large Cap Growth funds, whether indexed or not, have presented somewhat better returns over the last 10 years, and especially over the last several years, than the above mentioned broad indexes. By going with the broad indexes, you are assuming you are going to get a taste of everything with relatively good and relatively not-so-good performing stock groups balancing each other out. It's certainly one of the safest way to invest and many investors who use various methods to decide on holdings wind up doing far worse.

But is the basic thesis true that one can necessarily expect as good or better returns with these broad indexes than selecting from either indexed or managed funds that do not try to cover all bases but yet are not as narrow as sector funds such as those that strictly invest in areas such as energy or technology?

To see data shedding light on the above question, I examined the annualized returns from all domestic low minimum stock funds offered by Vanguard that have at least 10 year track records as compared to these two highly popular index funds as of 11/30/17. The results may surprise you.

The first table shows one, three, and 10 year returns for the broad index funds:

Compare these results for the Vanguard funds. Note that whenever the Vanguard fund equaled or outperformed either one or both of the broad indexes above, it is shown in dark (bold) type:

As you can see, it has been the minority of Vanguard stock funds that have been able to come out equal or ahead of either of these aforementioned broad index funds over the last one (35.5%) and three years (29%). However, over a 10 year period, nearly 3/4ths (74.2%) of Vanguard stock funds have accomplished this. While over the relatively shorter term, in a broad bull market, it may be best to own just about all stocks, over a complete market cycle that includes both at least one bull and bear market, investors may be able to do better by being selective in the type of stock funds they own. Thus, since 10 years ago, we begun suffering through a multiyear bear market, it may have paid off to give additional thought to the type of stocks and stock funds one chose to own.

While I cannot confidently explain why the majority of Vanguard funds did better than the indexes over 10 years as compared to more recently, a plausible explanation may be that as more and more investors moved into these broad indexes in the last several years, these investors started to become less interested in selecting specific investment "spots." In fact, while the indexes benefited, the alternatives tended to lose ground as compared to their performance for the earlier part of the decade.

In a separate comparison I performed, for the 7 years between Dec. 1, 2007 and Nov. 30, 2014, 80.6% of the Vanguard funds came out ahead of the broad index results. This supports the idea that index popularity over the last 3 years has been largely responsible for index outperformance more recently.

Will this broad index superiority continue? Perhaps, so long as investors stay enamoured of them. But I wouldn't assume the recent outperformance is a sure fire winning way to go.

First Quarter 2018 Model Portfolios

Welcome to 2018!

Although the calendar has flipped, I see surprisingly little to change the investment outlook. Of course, there may be unpredictable events that transpire to make 2018 quite a different year than 2017. However, by their very nature, these events, if they happen, are unknowable in advance, no matter what anyone tries to foresee in a "year ahead" forecast.

So, I am sticking largely with my overall view that stocks will likely continue to do a lot better than bonds. Whether bonds can continue to do better than cash is a reasonable question to ask, but I would still somewhat favor the former over the latter.

So, in the new Model Portfolios presented below, you will find only very minor changes from last Quarter's Portfolios. Let's hope that this year is even half as good as last year was.

Model Stock Portfolio

Notes:

1. A stock or bond fund shown with (C), (M), or (A) indicates it has characteristics that may make it most suited for Conservative, Moderate, or Aggressive investors, respectively.
2. Vanguard ETFs (exchange traded funds) are often practically identical to similarly named Vanguard "Investor" index funds with even lower expense ratios and without the higher minimums required for the "Admiral" funds. Therefore, these ETFs can be substituted for any Vanguard stock or bond index fund shown in tables. E.g. Vanguard FTSE Pacific ETF (VPL) can be substituted for VPACX; Admiral funds can also be substituted when available, e.g. VPADX.

Model Bond Portfolio

I am including the same funds as in the last Model Bond Portfolio, except for the removal of Vanguard GNMA (VFIIX) which previously had a 3% allocation. The reason: I do not expect US government bonds to do well in the current rising interest rate environment.

Notes:

1. When possible, select PTTRX, although the minimum initial investment is quite high; HABDX is nearly identical if you want a lower minimum.
2. The two funds are the same but have different minimums; select DBLTX if possible because of lower expense ratio.
3. Muni bonds are only suitable for taxable accounts. Invest in a fund with bonds specific to your own state, if available, for the greatest tax savings.
4. When possible, select PRRIX, although the minimum initial investment is quite high; HARRX is nearly identical if you want a lower minimum.

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