The US-based investment giant Vanguard has only been operating in this country since 2009, but it has already established itself as one of the major players in UK financial services.
Vanguard currently has around 635,000 UK customers with approximately £24 billion of savings, and about 50 million customers the world, mainly in North America. You may be familiar with its "V for Value" advertising campaign, which highlights its commitment to delivering value through low-cost investment options.
So how good a company is Vanguard? And is it a sensible choice if you’re looking for a firm to invest your money with?
There is certainly a great deal to admire about Vanguard. Its late founder, Jack Bogle, was an outspoken advocate for better investment outcomes. He was a passionate believer in putting customers first, reducing fees, greater transparency and investor education.
Bogle is best remembered as a champion of low-cost index funds. "The winning formula for success in investing,” he wrote inThe Little Book of Common Sense Investing, “is owning the entire stock market through an index fund, and then doing nothing. Just stay the course.”
But despite its close association with indexing, first and foremost Vanguard is, and indeed always has been, a provider ofactively managed funds. So are its active funds worth investing in?
Are Vanguard’s active funds any good?
If you’re vaguely familiar withrockwealth’sevidence-based investment philosophy, you will know that we don't recommend using actively managed funds. There is overwhelming evidence to show that, although there are bound to be winners in the short term, the vast majority of active funds underperform their benchmarks on a cost- and risk-adjusted basis over meaningful periods of time. What’s more, it's all but impossible to identify a future outperformer in advance.
There are several reasons why so few active funds beat the market. First of all, the financial markets are very efficient, so outperforming other investors, either through stock selection or market timing, is extremely difficult. Another very important reason is that active funds tend to be much more expensive than index funds, which means that they have to deliver a certain degree of outperformance simply to offset the additional cost entailed in using them.
Vanguard’s active funds do have a significant advantage over most of their peers in that they are relatively inexpensive. You are less likely to lag the market if you invest in a fund with lower fees than a typical high-fee active fund. If, as is likely, you do lag the index, you won't underperform by quite so much.
It's also true that some of Vanguard's active funds have outperformed in the past. But of course, it’s not past returns but the returns a fund will deliver in future that really matter. So the key question you need to ask is this:Is the alpha that Vanguard’s active funds have produced statistically significant? In other words, how certain can we be that it was down to skill, as opposed to random chance?
Index Fund Advisors, a financial advice firm based in California with a similar investment philosophy to our own, analysed the performance of all of Vanguard's US-domiciled active funds with five or more years of data. There are87 in total. 63.22% of them, or 55 out of 87, either didn't survive or underperformed their respective benchmarks since inception.
But the killer finding from IFA’s research was this one: of those 87 funds,not a single one outperformed its benchmark consistently enough since inception to provide 97.5% confidence that such outperformance could persist, as opposed to being based on random chance.
To put it another way, IFA’s analysis shows that, even if they invest with Vanguard, active investors are still effectively gambling. In the long run, they are likely to receive lower net returns than those who stick to Vanguard's index funds instead.
Should you just use Vanguard's index funds?
Now perhaps you’re thinking, “OK, I get it. Even though Vanguard’s active funds are cheaper than most active funds, I'm still highly unlikely to pick one now that genuinely outperforms over the long term. So I’ll just use Vanguard’s index funds instead.” So is a totally passive approach a good option? The simple answer is Yes, it is, but that doesn’t mean it’s thebest option.
Let me explain. When you invest in what’s called a Vanguard LifeStrategy fund, you get broad market exposure to equities in different sectors of the economy and in different countries around the world. You can also choose an allocation to bonds that reflects your capacity for risk. Assuming youstay invested and resist the temptation to dip in and out of the market, a LifeStrategy fund will give you near enough the market return, minus the modest fees you pay. Over the long term, on a properly risk-adjusted basis, the average passive investor will outperform the average active investor after costs.
So why isn’t a purely passive strategy with Vanguard necessarily the best one? Well, a LifeStrategy fund primarily invests in the biggest stocks in the world, or those with the highest market capitalisation. Owning so-called megastocks like Amazon, Tesla or NVIDIA will have had a very positive impact on your returns, particularly in recent years. Microsoft, for instance, has produced an average annual return of around 27% since the start of 2014. If you were simply invested in an S&P 500 index fund you were guaranteed to own all of the biggest publicly-listed stocks.
There will, however, inevitably be periods when very large-cap stocks fall out of favour and mid- and small-cap stocks outperform them. Indeed, as research by Eugene Fama and Kenneth French has shown, small caps have outperformed large caps and value stocks have outperformed growth stocks over the very long term. That's why it also makes sense for patient investors with a long time horizon to tilt their portfolios towards small and value stocks.
To be clear, there’s no guarantee that tilting your portfolio in this way will lead to long-term outperformance, but there is plenty of evidence to suggest that it will, provided you remain patient and disciplined.
Can we help you?
Here atrockwealth, we believe that both traditional cap-weighted indexing and tilting towards small and value stocks have their merits.
Interested in learning more?Get in touch and let’s arrange a meeting.
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