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Vanguard's Formula for Beating Mutual Fund Benchmarks

NEW YORK (TheStreet) -- In recent years, investors have poured into Vanguard Group's index mutual funds.

Since 2008, assets in Vanguard Total Stock Market Index (VTSAX) have more than doubled to $225 billion. At the same time, some shareholders have pulled money out of Vanguard's actively managed mutual funds.

Funds that have suffered outflows include Vanguard Windsor II (VWNFX) and Vanguard Capital Opportunity (VHCOX).

But in most cases, the shift away from active management has been a mistake.

According to a new study by Vanguard, the company's actively managed funds have outdone the index funds. On average, a dollar put into an active fund outpaced an investment in a comparable index fund by 0.79% annually during the past 30 years.

The findings must come as a jolt to many loyal followers of Vanguard and its founder John Bogle. During his long career in the mutual fund industry, Bogle has famously championed index funds. In speeches and bestselling books, Bogle argued that most investors should favor passive choices and avoid actively managed funds.

Over the years, Vanguard has published numerous studies on the virtues of indexing. The company has frequently argued that it is difficult to predict which actively managed funds will excel in the future. Now the latest study takes a different tone, arguing that investors "can be successful using actively managed funds."

Though the active funds have excelled through much of the past three decades, the margin of outperformance was particularly large during the past 10 years.

Among the star performers was Vanguard Capital Value (VCVLX), a large blend fund that returned 9.6% annually during the past decade, compared to a return of 8.0% for Vanguard 500 Index (VFINX), according to Morningstar.

Other active portfolios that outpaced index funds include Vanguard Equity Income (VEIPX) and Vanguard Morgan Growth (VMRAX).

Vanguard does not speculate about why the company has done so well lately. But it seems clear that most of the company's funds work to control risk, a factor that helped limit losses during the financial crisis.

Make no mistake, Vanguard's endorsement of active management is lukewarm. The study notes that while the company has succeeded, most active managers from competitors have lagged the benchmarks.

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