17 Managed Funds That Have Beaten The Indexes Over A 17 Year Period

What this appears to suggest is that outperformance by a broad index may be cyclical, that is, the index may excel over some years, or even over a number of years running, but one can hardly assume that the index won't underperform the average return of diversified funds for a number of years either.

Nevertheless, if one averages the differences over the entire 17 year period, the index fund still comes out ahead of the average fund by +0.5%. For advocates of index funds, this is just what they would expect. However, the relatively small margin of difference tells us that the result should be considered as entirely predictable, considering that the average fund charges quite a bit more than the index, accounting for all of the difference and even more. So, no real surprise here yet.

How much more does the average fund charge? According to a recent Morningstar article, the average most apparent cost, that is, the expense ratio, across all funds was about 1.2% in 2014, although higher in earlier years. The most recent cost of VTSMX is less than 0.2%. Thus, one is looking, at a very minimum, at about a 1% difference. Additionally, there likely will be another hidden cost within managed funds, namely the trading commissions whenever a fund manager buys or sells. Also excluded are instances if a managed fund charges an initial cost (load) when you buy or sell that fund.

Therefore, were it not for these higher costs subtracted from the average fund's pre-expense performance, the average fund might have actually beaten the index by a minimum of approximately 0.5% per year. In other words, it appears that, on average, the average mutual fund would clearly be as good or better in picking stocks than a broad market index except for the extra drag caused by the higher expenses. This could, incidentally, help to dispel the notion that the average fund manager, in spite of his presumed expertise, is actually a worse selector of stocks than those in the passive index.

Unfortunately though, these expenses do exist for the "average" fund, and at least for the above comparisons, we must declare the index fund the winner. I also found similar results when comparing the performance of the Vanguard Total International Stock Index with that of the average International stock fund, with some small variations. (These results will be reported at the end of this article.)

Now that the above data appear to have made a pretty convincing case for index funds giving better end results than managed funds, I will now present data that can lead to a very different conclusion.

How can this be? If one can identify managed mutual funds whose expense ratios (and possibly, other costs) are significantly less than the above average 1.2%, they, as shown by the above 17 years worth of data, should have a good chance of beating the passively managed broad indexes. So, for example, if the above data are indeed representative, by merely choosing managed funds that chop this average expense ratio in half (to 0.60), such funds, on average, should be able to beat the index, erasing the average 0.5 deficit.

These days such lower cost managed funds are not that hard to find. At least several fund companies have good lineups of funds with a much lower than average expense ratio. For example, Vanguard is well known not only for its low-cost index funds and ETFs, but for its nearly as low cost managed funds.

So how much better can low cost managed funds do than the above two index funds? While obviously not all low cost managed funds will do better than the index, Vanguard funds have a long-standing reputation for being excellent choices.

To answer this question, I searched the complete lineup of Vanguard managed funds to find all those that have been around since at least the start of 2000. There were 20 such funds. (Note: Just one generally available stock fund shut down over this period, which if excluded due to poor performance, might make the results for the remaining funds look better. However, the shutdown was due to other factors, not poor performance.) I then researched the yearly average performance of each of these funds and compared each to the yearly average performance of either VTSMX or VGTSX, depending on whether the particular fund's main focus was domestic or international stocks. The following table shows the results:

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