Vanguard Outperforms Index Mutual Funds

NEW YORK (TheStreet) -- Mutual-fund investors, fed up with big losses during the stock-market downturn, have been dumping their actively managed funds and shifting to index funds. The move to indexing is especially pronounced at Vanguard Group, which built its business model on index mutual funds.

During the past 12 months, assets have poured into Vanguard index funds. Inflows have totaled $11.2 billion for Vanguard Total Stock Market Index(VTSMX) and $2.1 billion for Vanguard Total International Stock Index(VGTSX), according to Morningstar. At the same time, assets have left many active funds. Outflows reached $1.1 billion for Vanguard Strategic Equity(VSEQX) and $1.5 billion for Vanguard Windsor II(VWNFX).

Buying index funds can be a wise move, but Vanguard investors shouldn't be quick to dismiss active funds. During the past decade, most Vanguard active funds outperformed comparable index funds.

To assess the performance of active funds, I looked at the 19 active Vanguard equity funds with 10-year records. Of those, 13 had outdone their benchmarks. In cases where Vanguard offered an index fund and an active fund in the same category, it usually paid to own the active fund.

Consider that Vanguard Equity Income(VEIPX), a large-value fund, returned 4.2% annually for the past decade, while Vanguard Value Index(VIVAX), a comparable index fund, returned only 1.9%. Despite its superior record, the active fund had outflows of $69 million in the past 12 months, while the index portfolio had inflows of $306 million.

Other active large-value funds that topped the index fund by wide margins include Vanguard Windsor(VWNDX) and Vanguard Windsor II. In the large-growth category, Vanguard Growth Index(VIGRX) lost 2.7% annually, while actively managed Vanguard Capital Opportunity(VHCOX) topped the index fund by 6 percentage points, and Vanguard Morgan Growth(VMRGX) won by a margin of 1 percentage point.

Why have the Vanguard active funds excelled? For starters, Vanguard has long had a sound track record for picking active managers. The company favors managers that produce steady results by following consistent disciplines. And when the managers have failed to produce solid results, Vanguard replaced them with better choices.

Besides looking for consistent managers, Vanguard has famously imposed low fees on its active funds -- almost the same as what it charges for index funds. Vanguard Windsor II has an expense ratio of 0.38%, compared to 0.26% for Vanguard Value Index. This is in contrast to most other fund companies which charge high fees on active funds. The average domestic equity fund has an expense ratio of 1.37%.