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Update: Active & Passive Funds Comparison

Posted by Sun on January 22, 2008
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Early this month, I read an article on USA Today with title, Index funds are never out of style. The article pointed out that for the past 10 years, the return of diversified US stock funds, which include small-, mid-, and large-cap funds, averaged at 6.7% while the S&P index returned 5.9% a year. The author of the article attributed the slightly superior performance of actively managed funds to what has been a remarkable run for small-cap funds during that period, during which small-cap funds outperformed large-cap funds by a sizable margin. However, things were a little different in 2007 as small-cap funds began to fade. The Russell 2000 index, which consists of small-cap companies, lost 2.67% last year, comparing to a gain of 3.53% of the large-cap S&P 500 index. From the article, one of the conclusions seems to be that with actively managed funds, the performance, sometimes even the fund itself, came and gone, just like small-cap funds may have run their course in 2007.

I used actively manged funds in our taxable investment when I started to buy mutual funds, although all the advices I have heard suggested using low-cost index funds instead because, on average, index funds outperform actively managed funds in the long term. At the end of 2006, I compared my mutual fund investments against some index funds from Vanguard in the same Morningstar category. The purpose of that comparison was to see how my funds were doing in both returns and costs of ownership. Now that 2007 was over, I feel it’s time to give that post an update and see if what I concluded a year ago still holds true after a tough year (at least the second half of the year) in the stock markets.

The comparison includes all the actively managed funds in our taxable accounts and the corresponding Vanguard funds that I think are most appropriate:

  • Alpine Dynamic Dividend (ADVDX) vs. Vanguard Mid Capitalization Index (VIMSX)
  • Buffalo Small Cap (BUFSX) vs. Vanguard Small Cap Growth Index (VISGX)
  • CGM Focus (CGMFX) vs. Vanguard PRIMECAP (VPMCX)
  • Dodge & Cox Stock (DODGX) vs. Vanguard Value Index (VIVAX)
  • Dodge & Cox International Stock (DODFX) vs. Vanguard International Value (VTRIX)
  • Oakmark Equity & Income (OAKBX) vs. Vanguard STAR (VGSTX)
  • T. Rowe Price Small-Cap Value (PRSVX) vs. Vanguard Small Cap Value Index (VISVX)
  • T. Rowe Price New Era (PRNEX) vs. Vanguard Energy (VGENX)
  • Third Avenue Real Estate Value (TAREX) vs. Vanguard REIT Index (VGSIX)
  • Tocqueville Gold (TGLDX) vs. Vanguard Precious Metals and Mining (VGPMX)

The costs and performances of these funds are listed in the following table.

My fund ER(%) Yield(%) 5-yr
return(%)		 Vanguard
fund		 ER(%) Yield(%) 5-yr
return(%)
ADVDX 1.18 13.57 6.70* VIMSX 0.22 1.29 14.11
BUFSX 1.01 0.0 15.47 VISGX 0.23 0.47 14.00
CGMFX 1.02 0.08 32.57 VPMCX 0.43 0.62 14.61
DODGX 0.52 1.54 12.57 VIVAX 0.21 2.63 11.87
DODFX 0.66 2.65 23.80 VTRIX 0.45 2.12 20.86
OAKBX 0.86 2.13 11.93 VGSTX 0.35 2.90 10.43
PRSVX 0.83 0.69 13.96 VISVX 0.23 2.28 11.89
PRNEX 0.66 0.84 26.68 VGENX 0.25 1.36 30.86
TAREX 1.11 1.91 17.12 VGSIX 0.21 4.94 15.72
TGLDX 1.50 0.80 24.71 VGPMX 0.35 1.81 33.29

* 3-year return

So what do I see from this table?

  1. Compared to one year ago, the fund expense ratios declined, though only by a very small amount.
  2. On one hand, I am quite happy with the ERs of my funds, though half of them still charge more than 1% fees. On the other hand, my cheapest fund, DODGX, still costs more than the most expensive Vanguard fund in my comparison list. When it comes the cost of owning a fund, Vanguard is hard to beat.
  3. None of my funds went out of business. In fact, three funds (BUFSX, DODGX, and PRSVX) are closed to new investors, which means that the fund managers have taken measures to prevent the growth of the assets from hurting the fund’s performance, a good sign of actively manged fund. Ironically, those three funds are among my worst performers in 2007.
  4. One year ago when I looked at the 5-year returns of my funds, I didn’t see the reason of not using actively managed funds. Today, while most of my funds still beat their Vanguard counterparts on average in the past five years, the performance difference when both expense ratio (ER) and yield are considered, became smaller (Note: The return data from Morningstar.com already subtracted fund expenses and included reinvested dividends) .

I will revisit this topic next year to see if my actively managed funds can hold up well over time.

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11 Comments
January 22, 2008

To be honest, when comparing apples to apples, I pay little attention to expense ratios. The returns that you see and that are reported are always net of fees anyway. So even if the fee is double compared to another fund, as long as the end result is a better return, that’s what matters to your bottom line.

A fund that returned 10% with a 1.0% ER compared to a fund that earned 10% with a 0.5% ER doesn’t matter, you still realized a 10% gain in the end.

But anyway, that is an interesting update, and there is certainly no reason to abandon active funds as long as they are performing in line with, or outperforming other similar investments.

Posted by Jeremy
January 23, 2008

The trick is finding the right fund.

Posted by Cliff
January 23, 2008

Jeremy: That’s a good point. I used return data from Morningstar which already took into consideration the fees and reinvested dividends. So only the total returns matter in the comparison. I will update the post accordingly :)

Posted by Sun
January 27, 2008

One factor for your comparison is missing — tax efficiency. You have the dividend yield part of the equation there but missing is the capital gains distribution number. For example, I hold DODGX also (luckily in my 401K). The 1.5% yield is not too far off from the comparison index but the 2007 capital gains distribution was a whopping 12%! So for somebody paying 15% LTCG + 9.3% CA tax, holding this in a taxable account effectively reduces 2007 returns by 3.3%. You do reclaim some of that by now having a higher cost basis but over the long run, you’d much rather have the deferred taxes over yearly tax drag.

Posted by MossySF
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