5 Index-Beating Vanguard Funds

The firm known for its index offerings has some great actively managed funds.

Vanguard has become synonymous with index investing, and its assets have swelled to more than $4 trillion as it has grown into the largest fund family in the world. But here’s something you may not know: About 30% of that money isn’t invested in index funds; it’s in actively managed funds. What’s more, many of those funds have long records of beating their indexes.

Dan Wiener, editor of The Independent Adviser for Vanguard Investors newsletter, found that 78% of Vanguard’s 18 domestic, nonsector, actively managed stock and balanced funds beat Standard & Poor’s 500-stock index over the past 15 years through last year. Fourteen funds outperformed the index, while just four lagged.

How do they do it? The most important strategy Vanguard employs is to charge low fees. Low fees have proved to be a remarkably accurate indicator of funds’ success in topping their benchmarks. Because Vanguard’s fund shareholders own the company, it doesn’t need to turn a profit. Thus, it can charge lower fees than the competition.

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“The argument against actively managed funds comes down to cost,” Wiener says. “There are lots of good managers, but they are hampered by huge operating-cost headwinds.” The average U.S. stock mutual fund charges 1.14% annually; Vanguard’s actively managed stock funds charge a weighted average of 0.29% for the Admiral shares.

But that’s not all Vanguard has going for it. Almost all of the best active funds Vanguard offers are run by outside managers. Most mutual fund firms hire employees to manage their funds. If the managers don’t produce, firing them can be difficult and damaging to company morale. Not so with outside advisers: Vanguard can pick the best, and if they stumble badly, it’s comparatively easy and painless to replace them.

Yet Wellington Management, one of Vanguard’s best outside firms, has worked with Vanguard since Jack Bogle founded the firm in 1975. In 1984, Bogle hired Primecap, which also runs several successful Vanguard funds. That tells me that the industry’s indexing pioneer is also a pretty fair judge of stock pickers.

A team of highly experienced people at Vanguard works full-time hiring, monitoring and, occasionally, firing the outside firms that run Vanguard funds. These overseers are not perfect, but overall, they’ve done a good job.

Most of Vanguard’s best actively managed funds are closed to new investors. Below are the three that are still open, as well as two that are near clones of closed Vanguard funds.

Vanguard Health Care (VGHCX (opens in new tab)) has long been my favorite sector fund. Manager Jean Hynes started working at Wellington Management right after graduating from Wellesley College. She has worked on the fund for more than two decades, becoming comanager in 2008 and sole manager in 2012, when longtime manager Ed Owens retired.

The health care sector has grown for decades at a faster rate than the overall economy, and I see little reason for that not to continue, no matter what happens in Washington. Aging baby boomers are using more health care, burgeoning middle classes in emerging markets are demanding health care, and innovative new treatments for diseases are being developed at a rapid pace.

The fund returned an annualized 10.9% over the past 15 years—an average of 3.1 percentage points per year better than the S&P 500. The Investor share class costs 0.37% annually; the Admiral shares (VGHAX (opens in new tab)) have a $50,000 minimum investment but charge less, 0.32%. Admiral shares are often available with lower minimums through online brokers. (All returns in this article are through May 12, unless otherwise noted.)

Vanguard International Growth (VWIGX (opens in new tab)) charges 0.46% annually for the Investor shares and 0.33% for the Admiral shares (VWILX (opens in new tab)). Compare that with 1.21% for the average diversified international stock fund. Over the past 15 years, the Investor shares of the Vanguard fund have topped the MSCI All-Country ex-USA index by an average of nine-tenths of a percentage point per year—more than the six-tenths of a point difference in expense ratios between the Vanguard fund and its average competitor. Two first-class foreign stock firms run International Growth. Baillie Gifford, based in Scotland, manages 60% of assets, and London-based Schroders manages the other 40%. These are huge firms with extensive experience and analysts all over the world. The managers aren’t afraid of volatile emerging markets, where the fund currently has 20% of assets.

Since its inception in late 1984, Vanguard Primecap returned an annualized 13.6%—an average of 2.5 percentage points per year better than the S&P. The fund, which charges 0.33% annually for its Admiral shares, is closed to new investors. But Primecap Odyssey Growth (POGRX (opens in new tab)), a near clone of Vanguard Primecap run by Primecap managers, is still open. It charges 0.65%. That’s not Vanguard-cheap, but it’s still much less than the average U.S. stock fund charges. Both funds have about 60% of assets in technology and health care stocks, with roughly 30% in each sector for Primecap Odyssey Growth.

Vanguard Primecap Core (VPCCX (opens in new tab)) is a more conservative Primecap fund, which is also closed to new investors. Primecap Odyssey Stock (POSKX (opens in new tab)) is a near clone with an expense ratio of 0.67%. Odyssey Stock is less volatile than Odyssey Growth and tends to hold up better in bear markets. You’ll find more big tech and drug stocks in the former; the latter has more start-up tech and biotech stocks. Either fund gives you the patient, contrarian growth strategy that has made Primecap so successful for more than three decades.

Wellington Fund was launched in 1928, almost a half century before Bogle founded Vanguard and brought the fund under the Vanguard umbrella. It’s an old-fashioned balanced fund: Roughly two-thirds of assets are in stocks, and the remainder is in bonds. Stock manager Edward Bousa looks for undervalued, dividend-paying, large companies with competitive advantages over their peers. His conservative approach, along with the bond stake, means the fund tends to hold up relatively well in bear markets. Three bond managers stick to high-quality bonds with, on average, intermediate maturities.

Over the past 15 years, the fund returned an annualized 7.9%—an average of two-tenths a percentage point per year more than the S&P. Yet it was 34% less volatile than the S&P during that stretch. Given how low interest rates are today and how high bond prices are, I don’t expect returns to be nearly as strong relative to the S&P going forward. But Wellington should continue to be a relatively low-risk fund suitable for conservative investors. Expenses for the Investor shares (VWELX (opens in new tab)) are 0.25%. The Admiral shares (VWENX (opens in new tab)), with the $50,000 minimum, cost just 0.16% annually. Wellington is available only if you buy it directly from Vanguard.

Steve Goldberg (opens in new tab) is an investment adviser in the Washington, D.C., area.

Steven Goldberg
Contributing Columnist, Kiplinger.com
Steve has been writing for Kiplinger's for more than 25 years. As an associate editor and then senior associate editor, he covered mutual funds for Kiplinger's Personal Finance magazine from 1994-2006. He also authored a book, But Which Mutual Funds? In 2006 he joined with Jerry Tweddell, one of his best sources on investing, to form Tweddell Goldberg Investment Management to manage money for individual investors. Steve continues to write a regular column for Kiplinger.com and enjoys hearing investing questions from readers. You can contact Steve at 301.650.6567 or sgoldberg@kiplinger.com.