Editors' pick: Originally published March 22.
Smart-beta funds fall somewhere between index and active management because they are rules-based. That does not make them better performers, said Francis Kinniry, a principal in Vanguard Investment Group.
"We know indexing has outperformed 70% to 80% of active managers, so writing down a rule on the back of a napkin like 'value' or 'avoid large-cap stocks' is going to be difficult. And the performance bears that out," said Kinniry. "'Smart-beta' strategies have done very poorly since they came out."
Kinniry said it is okay to mix index and actively managed funds in a portfolio as long as the fund manager brings a lot to the table.
"What you really need for active is high talent, high skill and low costs," said Kinniry.
One area being hotly debated right now is whether investors are better off in an actively managed high yield fund or an exchange-traded fund like the SPDR Barclays High Yield Bond ETF (JNK) - Get SPDR Bloomberg Barclays High Yield Bond ETF Report or the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) - Get iShares iBoxx $ High Yield Corporate Bond ETF Report . Kinniry admits that actively managed high yield funds have outperformed in the past one to three years, but he would not go all the way in recommending them.
"From a portfolio construction standpoint, high yield will correlate closer to the equity markets, so we actually call it 'chicken equity," said Kinniry. "Be a little careful if you have your equity allocation and then use high yield, because it's probably going to underperform in an equity bear market."
For those looking for yield in this continuing low-yield environment, Kinniry said investors should not chase high dividends.
"We have been warning investors for quite a while that dividend strategies that have high yields look a little inflated on valuation metrics," said Kinniry. "We believe in a total return. So don't engineer your portfolio for high income. Keep it very diversified and spend out of your total return."