In an environment when U.S. based active equity funds continue to feel investor’s wrath, it’s the passive funds that are attracting investor attention. Huge inflows into passive funds are helping the overall equity funds to register inflows. Separately, funds managed by Vanguard, one of the leading fund managers, registered the highest inflow in recent times, easily outpacing its other competitors.

In this scenario, adding favorably ranked passive mutual funds that are managed by Vanguard to one’s portfolio may boost returns in the days ahead.

Healthy Inflows into Passive Funds

According to a recent Morningstar report, actively managed U.S. equity funds saw an outflow of $32.93 billion, which was preceded by a withdrawal of $21.7 billion in June. Unlike active funds, investors poured in nearly $33.81 billion into passive funds, significantly higher than June’s inflow of $8.7 billion. The surge in inflows in passive U.S. equity funds led total inflows in this category to $877 million.

Moreover, all the categories under passive funds registered inflows, most of the active fund categories posted outflows in July. The report also showed that passively managed U.S. equity funds registered a huge inflow of $163.6 billion over the 12-month period ending in July, in contrast to a massive outflow of $211 billion witnessed by actively managed funds. Moreover, taxable bond funds, which emerged as one of the few categories registering inflows among active funds categories, registered a total inflow of $34.0 billion in July with passive ones attracting the major part of it.

Advantage of Passive Funds over Active Ones

Passive funds are expected to be less risky compared to their active counterparts. Passive funds witness less trading activity than active portfolios and thus are poised to avoid the risk of human errors faced by active funds. Meanwhile, a lower expense ratio  compared to active funds also played an important role in boosting the demand for passive funds in the recent times. As per Lipper, equity funds that are actively managed have an average expense ratio of 1.4%, significantly higher than 0.6% recorded by their passive counterparts.

Moreover, active funds are poised to be more volatile compared with the passive ones. While a passively managed fund or passive index fund is designed to resemble a broader market index and provide performance identical to it, funds that are actively managed seek to deliver profits higher than the industry barometer, which the fund is designed to beat. In this process, active funds are more exposed to volatility.

Why Vanguard?

After adding nearly $230 billion last year, which is undoubtedly higher than other fund families, Vanguard funds attracted nearly $158 billion from the beginning of the year  through July. It currently holds the biggest chunk of market share among all fund families. As of July, Vanguard’s market share was 21.9% followed by American Funds’ share of 8.4%. It was also higher than 19.9% market share registered in the year-ago period. It indicates that Vanguard is ahead of other fund families when it comes to attracting investor attention.

The company’s important property of offering low-cost choices is one of the main factors behind Vanguard’s popularity. While average expense ratio across all the funds managed by the company currently stands at 18 basis points, on the basis of asset-weighting, average expense ratio is down further to 0.13%. Low-cost advantage played an important role in helping the company to outpace its competitors over the past few years.

3 Mutual Funds to Buy

Given this encouraging backdrop, we have highlighted three passively managed Vanguard mutual funds that also come with low expense ratios and with no sales load. These funds also carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or #2 (Buy). We expect these funds to outperform their peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund.

These funds also have encouraging year-to-date, and three- and five-year annualized returns, and the minimum initial investment is within $5000.

Vanguard High Dividend Yield Index Investor (VHDYX - MF report) employs an indexing investment approach designed to track the performance of the FTSE High Dividend Yield Index. Annual expense ratio of 0.16% is significantly lower than the category average of 1.11%. This Mutual Fund Rank #1 product has year-to-date, and three- and five-year annualized returns of 10.8%, 12.2% and 14.8%, respectively.

Vanguard Tax-Managed Small Cap Admiral (VTMSX - MF report) seeks to replicate performance of the S&P SmallCap 600 Index by investing in the index’s components in identical proportions as in the index. Annual expense ratio of 0.11% is significantly lower than the category average of 1.24%. This Mutual Fund Rank #2 product has year-to-date, and three- and five-year annualized returns of 12.5%, 11% and 15.1%, respectively.

Vanguard Growth Index Admiral (VIGAX - MF report) attempts to imitate the CRSP US Large Cap Growth Index by investing in all the stocks that make up the index. Annual expense ratio of 0.08% is significantly lower than the category average of 1.17%. This Mutual Fund Rank #2 product has year-to-date, and three- and five-year annualized returns of 5.9%, 12.8% and 14.6%, respectively.