Index Tracker Continues To Beat Managed Funds And Probably Always Will

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index trackers

Index Tracker Continues To Flourish

My lovable US Equity index tracker…if you’re a regular reader of my website, you’ll know I love ultra low fee U.S Equity index tracker funds. Even more so now Fidelity introduced their gamechanger 0% fee version. (The Zero Fund is currently only available in the USA with no announced plans of a UK version yet, but Vanguard UK’s US Equity Fund version only charges a 0.10% fee).

Most investors I speak with simply don’t understand the huge advantages a low fee index tracker offers. Financial advisers rarely offer their clients an index tracker arguing that managed funds are superior because fund managers are the expert stock pickers. The long-term US Equity index tracker return numbers don’t lie. Managed funds pay financial advisers far greater commissions and fees so it’s easy to see why advisers rarely ever recommend index trackers to their clients. It’s one of the biggest issues with the financial advising world.

Recently my American friend asked me to look at some funds her adviser wanted to invest her money into. It’s an interesting case study so I thought I would post the charts here and it may give you a good reason to analyse your own portfolio.

On each chart, I compare each recommended funds’ performance to Vanguard USA’s US Total Stock Market Index Tracker Fund (VTSMX). Be sure to pay attention to the high trading turnover rates of each managed fund. Turnover rates are how often stocks are traded in and out of a fund over a year. High turnovers result in high trading fees and tax expenses on profits. Remember, funds have to pay for each stock trading transaction just like we do. For example, if a fund’s turnover rate is 100%, that means every single stock in the portfolio is turned over / traded once per year. If the fund is making millions of trading transactions annually, those fees are paid by the funds investors.

Back to our case study. Here are the funds my friend was advised to buy:

Recommended Fund 1: SEI Global Managed Volatility Fund (SVTAX)

This managed equity fund is made up of companies such as Pepsi, McDonalds, Mastercard and Home Depot. The fund’s turnover rate is 61% meaning that 61% of the entire stock portfolio is traded over a year. Remember high turnovers equal high trading fees and tax expenses.

Vanguard’s Total Stock Market tracker outperformed this managed fund by 118% over a 10 year period:

Recommended Fund 2: SEI Institutional Managed Trust Small Cap Growth Fund (SSCGX)

This managed equity fund is made up of small companies which makes it highly volatile. The turnover is 116% meaning the entire portfolio is traded 1.16 times over a year.

Vanguard’s Total Stock Market tracker outperformed this managed fund by 71.75% over a 16 year period.

Notice also how the fund almost identically mirrored the S&P 500 index yet performed so poorly. This is because of the poor stock picking choices and the added fees the fund incurred.

 

Recommended Fund 3: SEI Large Cap Value Fund (TRMVX)

This managed equity fund is made up of large companies such as Exxon, AT&T, Pfizer and Intel. Its turnover is 76% meaning 76% of the entire portfolio is traded yearly.

Vanguard’s Total Stock Market tracker outperformed this managed fund by 98.15% over a 16 year period.

Recommended Fund 4: SEI Large Cap Growth Fund (SELCX)

This managed equity fund is made up of large companies such as Amazon, Apple, Mastercard and Microsoft. Its turnover is 95% meaning 95% of the entire portfolio is traded yearly.

Vanguard’s Total Stock Market tracker outperformed this managed fund by 107.95% over a 16 year period.

I suggested my friend return to her adviser and ask him why these funds were recommended versus a low fee, better performing, low turnover index tracker fund.

Since the beginning of 2018, I’ve been receiving little snippets of index tracker news that have made me smile.

For example, the most famous investor in the world, Warren Buffet, was so confident in his long-standing advice that all an investor needs is an S&P 500 or a broad market index tracker, he made a $1 million bet supporting his claim. Buffet isn’t usually a gambling man, but he knew this bet was one he was likely to win.

Buffet bet $1 million that investment company Protégé Partners human stock pickers couldn’t beat an S&P 500 index tracking fund. The bet was to last ten years so this wasn’t a short-term. Buffet was determined to show that actively managed funds can rarely beat index tracker funds due to the large fees, expenses and human stock picking errors. Over the 10 year bet period, the S&P 500 index tracker fund averaged 7.1% per year while the human stock pickers averaged just 2.2%. Buffet won the bet and donated his winnings to charity.

This was a terrible bet for Protégé Partners with no upside. Protégé Partners had little chance of outperforming the S&P 500 index. The realistic best case scenario for Protégé was that they beat the S&P 500 tracker fund by a small percentage. Instead, Protégé Partners picked underperforming stocks and funds (because they can’t predict the future) and in turn, attracted some very negative attention towards their investment firm.

My favourite quote from The Daily Mail article about the bet was from Ben Yearsley, an adviser at Shore Financial Planning. He said, “Trackers are a good choice if you want to keep your costs down — but you have to accept that the only way you can beat the stock market is to pick a good fund manager.”

Then the question becomes, “what is a good fund manager?” Neil Woodford, who was touted as one of the greatest fund managers, hasn’t been able to beat the index with his Equity Income Fund:

Today I received a 2018 outlook summary from my mother’s financial adviser. The outlook report ended by stating, “…we expect active management to come into its own.” I believe this statement is amusing and here’s why.

If you look at Invesco’s massively popular and successful High Income Equity Fund, you’ll notice how the peaks and valleys closely match the S&P 500’s:

index funds

So why does the above actively managed Invesco fund mirror the S&P 500 so closely? The answer is because the stocks held inside most actively managed funds do poorly when the S&P 500 index does poorly and vice versa. Despite the Invesco fund performing adequately compared to the S&P 500, when Invesco’s fees and expenses are included for the 10 year period, the Invesco Fund underperformed the S&P 500 index. The point here is that even one of the few successful managed funds couldn’t beat the index.

Out of the thousands upon thousands of managed funds, only a tiny percentage manage to match the indexes over a long period of time, and even then, success in buying actively managed funds is highly dependant on investing in them at the correct time. A difficult task to say the least.

Of course, I would expect most advisers to promote active management. If advisers suggested, “active management has no place in your investment portfolio, buy an index tracker”, they would be quickly out of business.

Financial advisers are nervous as they see hundreds of millions of currency being poured into index trackers. Investors are becoming wise as they understand high fees and expenses are sucking the returns out of actively managed funds. Fund managers continue to receive mouthwatering bonuses and salary increases even when their fund performance is poor. Please don’t ever forget that every fund investor pays for these large salaries.

For those of us who want hands-off, hassle-free investing, an index tracker is beneficial because low fees are the key to long-term investing success. Index tracker funds are able to keep fees ultra-low because their stock portfolio turnover is lower (meaning less trading of stocks) and therefore, lower trading charges and lower capital gains tax. The lower the fees and expenses, the better the returns. Makes sense right?

In an industry changing move, Fidelity USA is now offering a completely fee-free index tracker, designed to poach away some of Vanguard’s customer.

As of August 2018, Vanguard’s U.S. VTSAX Total Stock Market Tracker contains over $725 billion in assets while charging a minuscule 0.04% fee, while the UK version charges an annual fee of 0.10%, has a turnover rate of only 1.9% and contains £3.4bn in share assets.

When the stock market eventually corrects, I expect nearly all actively managed equity funds to perform just as poorly as the S&P 500. So knowing this, I’ll continue to save myself the high fees and expenses of managed funds and financial advisers and invest solely in index tracker funds.

Read next: Which index trackers I buy and why I dislike FTSE 100 trackers.


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Disclaimer: This article is for information purposes only and should not be regarded as investment advice. Opinions expressed are my opinions based on my own personal experiences, investing my own money.