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By Aaron Levitt
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Vanguard funds are top of mind when it comes to index investing. After all, founder John Bogle basically created the idea of passive investing and brought index funds to masses back in the 1970s.
But Vanguard's actively managed funds should be on equal footing with their passive brethren.
One of the biggest hurdles to actively managed mutual funds and exchange-traded funds (ETFs) is something called a "fee hurdle." Historically, active funds cost more to run than a passive index-tracking fund. Because of this, an actively managed fund must earn more than its fees in order to bring investors a return. So even if a fund does beat the underlying index or benchmark, the higher fees will often produce lower returns.
But for Vanguard, low-cost investment management is in its blood. As a result, Vanguard's actively managed funds feature rock-bottom fees just like its passive investment options. This allows many of its active funds to offset the fee hurdles that other firms encounter and gives investors the opportunity to benefit from active management outperformance at lower costs.
With that in mind, here are five of Vanguard's active funds to own for the long term. The funds featured here cover a variety of strategies, so there's likely a low-cost option that aligns with your goals, no matter what type of investor you are.
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Disclaimer
Data is as of March 10. Dividend yields represent the trailing 12-month yield, which is a standard measure for equity funds.
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Vanguard Selected Value Fund
- Fund category: Mid-cap value
- Assets under management: $6.7 billion
- Yield: 1.2%
- Expense ratio: 0.32%, or $32 annually for every $10,000 invested
- Minimum investment: $3,000
One area where active management can win over passive is in the world of smaller stocks. Major investment houses, analysts and institutional investors tend to ignore small- and mid-cap stocks. As a result, there can be plenty of pricing inefficacies that smart managers can exploit. This is particularly true when focusing on value stocks in this region.
The top-performing Vanguard Selected Value Fund (VASVX, $29.66) looks to cash in on this fact.
VASVX focuses on mid-cap stocks, or those with market caps within the $2 billion to $10 billion range. Managers at the fund then use fundamental analysis to find stocks that are undervalued and out of favor, trading at below-average levels for various financial metrics such as earnings or book value. What you get is a one-two punch of success.
Returns for the fund tend to go through periods of significant outperformance and slight underperformance versus its benchmark the Russell Midcap Value Index. However, returns over the past one year and three years have exceeded those of the underlying benchmark (by 2.7 percentage points and 1.9 percentage points, respectively).
The Vanguard Selected Value Fund is concentrated, with only 127 stocks in its portfolio. This compares to nearly 700 for its benchmark. The fund is top-heavy in financials (25.8%), followed by industrials (19.9%) and consumer discretionary (15.4%). Major holdings for VASVX include apparel manufacturer Gildan Activewear (GIL) and insurer Unum (UNM).
With impressive near-term returns and a low 0.32% expense ratio, the Vanguard Selected Value Fund could be a top choice among actively managed Vanguard funds for your portfolio.
Learn more about VASVX at the Vanguard provider site.
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Vanguard Short-Term Investment-Grade Fund Investor Shares
- Fund category: Short-term bond
- Assets under management: $75.6 billion
- SEC yield: 2.1%*
- Expense ratio: 0.20%
- Minimum investment: $3,000
Fixed income is another area where active management can often boost returns versus passive/index funds. The reason? Most bond indexes are constructed via a weighting scheme that prioritizes the total amount of debt issued. Basically, those firms with more debt make up more of the index. That's counterintuitive.
Active managers can focus on credit research, look at underlying cash flows, business trends, etc., in order to make the best selection on undervalued bonds. And that's what you get with the Vanguard Short-Term Investment-Grade Fund Investor Shares (VFSTX, $10.41) – a member of the Kiplinger 25, our list of high-quality, low-cost mutual funds.
VFSTX focuses its attention on short-term and intermediate-term investment-grade fixed-income securities. These can include Treasury bonds and corporate securities. Where the bond fund wins is that it is overweight corporate bonds relative to Treasuries versus its underlying benchmark, the Bloomberg Barclays US 1-5 Year Credit Index.
What does that do? First, it helps the fund produce a higher yield – 2.1% versus just 1.7% for its index-tracking sister, the Vanguard Short-Term Bond Index Fund Admiral Shares (VBIRX). Albeit, it is a slightly different tracking index.
Secondly, it produces lower overall volatility than the broader short-term bond index. That's due to the credit analysis from the underlying managers. The combination is a strong, cash-like fund that can help buoy an investment mix. And given its short duration – 2.8 years, on average – the Vanguard Short-Term Investment-Grade Fund Investor Shares will be able to absorb any increases to interest rates better than longer-dated funds.
Given its low expense ratio of 0.20%, VFSTX is one of the best actively managed fixed-income Vanguard funds for your portfolio.
Note: VFSTX also trades as Admiral class shares (VFSUX).
* SEC yields reflect the interest earned after deducting fund expenses for the most recent 30-day period and are a standard measure for bond and preferred-stock funds.
Learn more about VFSTX at the Vanguard provider site.
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Vanguard Tax-Managed Balanced Fund Admiral Shares
- Fund category: Moderate allocation
- Assets under management: $8.5 billion
- Yield: 1.5%
- Expense ratio: 0.09%
- Minimum investment: $10,000
The general mantra for much of the financial planning community is to fill your retirement accounts and other tax-free/tax-deferred vehicles first before even considering a taxable account. However, these days, you can run a taxable account pretty efficiently and there are plenty of reasons why having one makes sense for investors.
And Vanguard lets you have your cake and eat it, too, with the Vanguard Tax-Managed Balanced Fund Admiral Shares (VTMFX, $39.35).
As a balanced fund, VTMFX owns both stocks and bonds – set at roughly 50% apiece for each asset class.
In this case, the bond sleeve is made up of municipal bonds with a dollar-weighted average maturity of six to 12 years that mostly (at least 75%) have top credit ratings. Distributions from munis are free from federal taxes and, in many cases, state and local taxes as well.
On the stock side of the equation, the fund will only include stocks on the Russell 1000 Index that pay qualified dividends or none at all. Top holdings at present are mega-cap stocks Apple (AAPL) and Microsoft (MSFT). What's more, managers at the fund are buy & hold fans, with a turnover rate of just 20%. Holding stocks for these extended periods of time helps to reduce taxes.
The combination of municipal bonds and buy-and-hold investing has produced some pretty decent returns. Since its inception in 1994, VTMFX has managed to produce a 7.8% annual total return through Feb. 28. That's not too shabby at all considering half the fund is in boring municipal bonds. Also helping investors is the fund's low 0.09% expense ratio.
One downside to the fund is its high initial investment minimum. To own VTMFX, you'll need to pony up $10,000. But if you use one of Vanguard's financial advisors, the investment minimum is waived. In fact, it is for all Vanguard funds – though you'll need to invest a minimum of $50,000 to work with one of their advisors.
Learn more about VTMFX at the Vanguard provider site.
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Vanguard International Growth Fund Investor Shares
- Fund category: Foreign large growth
- Assets under management: $58.8 billion
- Yield: 1.0%
- Expense ratio: 0.43%
- Minimum investment: $3,000
If you're a U.S.-based investor, it's easy to find and research information on Apple or Coca-Cola (KO). But French luxury stock Kering SA (PPRUY)? Not so much. As a result, we often ignore opportunities presented overseas and succumb to a hometown bias. Active management and specialists can play a great role in finding top international stocks and help improve opportunity sets and returns in a portfolio.
And one of the best international funds happens to be the Vanguard International Growth Fund Investor Shares (VWIGX, $34.77), which owns both developed and emerging market stocks of various sizes.
The key comes down to the fund's advisors: Baillie Gifford and Schroder – both of which have long histories of investment management under their belt. For VWIGX, Baillie Gifford tends to look for companies with sustainable earnings and free cash flow growth, while Schroder will look for those growth stocks trading at more reasonable prices. The dual mandates create a fund of strong growth stocks with a side of value.
There's concentration as well. Despite having over nearly $59 billion in assets, the fund only owns 121 stocks.
All of this has led to outperformance over the intermediate and long term. In the last 10 years, for instance, VWIGX has managed to produce an average annual return of 10.5%. That's about double the average annual return for its benchmark – the MSCI All Country World Index ex USA – over that same time frame. This is one instance where active really does work better than an index. Also helping is the fund's low 0.44% in expenses.
VWIGX is one of the best actively managed Vanguard funds for investors to gain exposure to foreign stocks.
Note: VWIGX is also available in Admiral shares (VWILX).
Learn more about VWIGX at the Vanguard provider site.
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Vanguard PRIMECAP Fund Admiral Shares
- Fund category: Large growth
- Assets under management: $69.4 billion
- Yield: 0.8%
- Expense ratio: 0.31%
- Minimum investment: $0
If there is one flagship active mutual fund under Vanguard's umbrella, it has to be the Vanguard PRIMECAP Fund Admiral Shares (VPMAX, $151.59). VPMAX has long been one of the best-performing active stock funds in history – generating an 11.2% average annual return since 2001. That return has managed to beat the S&P 500 by over 2 percentage points annually during that time.
The secret sauce comes down to the fund's strategy.
VPMAX focuses its attention on GARP stocks, or growth at a reasonable price. Here, managers seek to blend growth and value styles of investing, looking for high rates of revenue and profit growth, but not paying too much for those rates of growth. GARP as a style is hard to do, but when you do it right – as managers do with PRIMECAP – it can produce solid returns for a portfolio.
The second way that VPMAX wins is that it's fairly concentrated, holding just 161 mid- and large-cap stocks despite its $69 billion in assets. Top holdings at the moment include drug manufacturer Eli Lilly (LLY) and creative cloud superstar Adobe (ADBE) – both of which are targeted for earnings-per-share growth in the double digits over the next three to five years, according to S&P Global Market Intelligence.
As a note, the Vanguard PRIMECAP Fund Admiral Shares is currently closed to new investors not enrolled in Vanguard Flagship Services or Personal Advisor Services – though its sister fund (VPMCX) is still found in many 401(k) retirement plans. However, the PRIMECAP Odyssey Growth Fund (POGRX) – another member of the Kiplinger 25 – features a similar strategy and has the same managers. As far as active Vanguard funds are concerned, POGX is a reasonable alternative to VPMAX.
Learn more about VPMAX at the Vanguard provider site.
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Aaron Levitt
Contributing Writer, Kiplinger.com
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