Vanguard's stockpickers outperform despite firm's passive push

Vanguard Group became the largest U.S. fund manager by assets by persuading investors that they don't need to pay for a stock picker. Yet a funny thing happened along the way: Most of the 30 active stock funds the firm runs have actually beaten their respective benchmarks and Vanguard's own highly touted index funds.

Over the last three years, 20 out of Vanguard's 30 actively managed stock funds outperformed their benchmarks by an average of 1.1 percentage points a year, according to Lipper data. Under lead manager James Stetler, the $615 million Vanguard Strategic Small Cap Equity Fund, for example, topped its index by 3.2 percentage points a year over the same period.

Even in the large-cap stock space, where indexing is supposed to deliver the greatest value, the $13.8 billion Vanguard Capital Opportunity Fund has outperformed the S&P 500 index by 6.5 percentage points a year for the last three years. An investor who put $10,000 into the Vanguard Capital Opportunity fund on Dec 13, 2011, would now have $20,081, according to Morningstar, or $2,884 more than if she had invested in Vanguard's flagship S&P 500index fund.

For most firms, such performance would quickly work its way into an advertisement. Yet Vanguard says little about its actively-managed line of funds, which receive most of their assets from 401(k) and other employer-sponsored plans and account for about $940 billion in assets under management. Vanguard overall has $2.96 trillion under management.

Some of that likely stems from the influence of firm founder Jack Bogle, who launched the world's first index fund in 1976 and has done more than anyone else to make indexing mainstream. Before then, Vanguard was - like every other fund company - a firm that was focused solely on active management.

"If the data do not prove that indexing wins, well, the data are wrong," Bogle wrote in the Little Book of Common Sense Investing (Wiley), a book published in 2007 that lays out his philosophy that active management, with its attendant higher fees, can't win. He did not respond to a request for comment for this story.

Yet the performance of portfolio managers running Vanguard funds suggests that stock picking is not a fool's errand, as some of Bogle's most devoted fanatics, known as Bogleheads, make it out to be.

Vanguard's attempt to walk the line between touting passive investing while also holding approximately a third of the firm's overall assets in actively-managed funds could be complicated if its active funds continue to outperform, said Todd Rosenbluth, director of mutual fund research at S&P Capital IQ.

But the firm is not worried about losing the loyalty or assets of the indexing adherents it has picked up in recent years. Stock picking funds attract "a different type of client" who has time and interest to research fund managers, said Daniel Newhall, a principal in the firm's Portfolio Review Group.

STOCKPICKERS LAG

Overall, Bogle's point about passive investing seems to hold.

For the year to date, 73 percent of actively-managed value funds are lagging the approximately 8 percent gain in the S&P 500 index, while 94 percent of actively-managed growth funds are underperforming the benchmark, according to S&P Capital IQ.

Vanguard's outperformance has probably been at least in part due to what Newhall, the Vanguard principal, calls the "common thread" of all the firm's funds: low costs.

Vanguard charges an average of 41 cents per $100 invested in its actively-managed stock funds, compared with an average of $1.25 among all actively-managed stock funds, according to Lipper data.

Those low fees, and strong performance, haven't led to a flood of assets. For the year to date, Vanguard has brought in $118 billion into its passive stock funds and exchange traded funds, according to Lipper data, compared with just $1 billion in new money invested in its funds run by stock pickers.

The company will likely continue to put its emphasis on passive investing, which is the strongest part of its brand, Rosenbluth, the fund analyst, said. Yet the actively managed funds allow it to keep investors who do want an element of stock picking in their portfolios from sending money to rivals such as Fidelity Investments or Charles Schwab Corp, he said.

"They're going to go with the firm they already like and trust," he said.