To begin with, I am not trying to offer a statement "Managed funds are the devil!" I know there are times when managed funds offer something to be considered, such as a few of my friends recently offered, that sometimes the psychological factor alone is enough to hold a managed fund. Funds such as have been offered such as Wellington and Wellesley offer benefits of less risky stocks and shorter term bonds for a 'One stop' fund for the investor who does not care to study investing, and wants a little less volatility than they might find in a balanced index fund -- and quite possibly some superior returns per the asset allocation due to stocks focused more toward the giant value side and the bonds the shorter corporate side.

I also have already asked the question "Why managed funds?" to get a better idea as to why folks insist on investing in managed funds, and agree with what Petrocelli had to say, in that when selecting managed funds, select them as you would an index funds.

Some of the most obvious answers to this question were offered by Taylor in the Active -vs.- Managed thread;

I have already offered what Jack Bogle offered when studying all managed funds;

This is of course only one of his numerous speeches showing the advantages of the index fund, and while Jack Bogle was doing this, another, Burton Malkiel was doing the same as evidenced in his "Random Walk" books.

Vanguard offers a little something on this;

Here is the executive summary for those who don't care to read the whole thing;

Vanguard uses this knowledge to better not only their index funds, but managed funds as well.

It has been said a few times here, " . . . but this is long-term!" -- True. In some short periods higher percentages of the managed funds will perform better than the so-called ‘Market‘, but this is due to one of the factors besides costs that drag down the returns over time -- cash drag. Cash (and/or bonds) offer better returns and less volatility in the periods when the market as a hole, or large caps do not do well. In other periods even those without the cash drag will perform better than the market. This is due to taking value, size and sector risks the market does not. These risks do not show up in all periods.

Eugene Fama and Kenneth French developed a Three Factor Model to study the returns of managed funds compared to an indexed portfolio built on their observed factors of risk/return, which boils down to how much alpha the manager actually gains considering they could have invested in a portfolio of funds with DFA indexed toward the sectors of the market based on Fama/French small/value indices. To cover bonds and cash in the managed funds, they developed a four factor and five factor model. Using the Fama/French models show 95% of the returns of a mutual fund can be explained by the markets in which they invest. It can explain the returns of the funds in the short periods;

All-in-all, it doesn't appear managed funds are capable of beating the index funds, even in the short-term, unless of course the managed fund invests outside the market you can reach with index funds. When looking at stand alone managed funds and their performance, their success should be considered using the Fama/French 3Factor (or 4 or 5). Possibly what will explain beyond the 95% this model covers is the sector weightings of the fund, such as healthcare, REITs, metals, energy, &c. when these sectors are returning higher than historic returns.

The often looked at 10 year period compared to the S&P 500 in a period when the S&P 500 has offered poor returns does nothing to explain the returns of managed funds. A simple way to compare the managed fund would be to compare it against something like the Four Pillars Vanguard Portfolio as offered in William Bernstein's "The Four Pillars of Investing" (or if you prefer "The Intelligent Asset Allocator" which the portfolio can be dated back 10 nearly 10 years ago now).

The portfolio can be found here;

If you just want to see how managed funds have done against index funds, look at the simple Coffeehouse portfolio which can be found in the above link or here;

Bill Schultheis offers his own reasons to "Why indexing?"

Once again, this is not meant to be focused on the superiority of index funds, or to say do not invest in managed funds, but maybe as Petrocelli offered, look at managed funds the same as you do index funds. As opposed to the claims of Efficient Market Hypothesis (EMH), Jack Bogle's Cost Matters Hypothesis (CMH ;) is difficult to argue.

Maybe the question should have been "Why Vanguard?", as over the years, Vanguard has been concentrating on lowering costs by not trying to beat the market or their prospective benchmarks through managers trying to beat the millions of other stock traders, but by reducing the costs of their funds by not trading and paying analysts high wages for a "Zero sum" game.

As offered in EMH, any anomaly that can be exploited can be quickly recognized, copied, and taken advantage of to the point the anomaly disappears. It appears other fund companies have noticed what Vanguard is doing, and trying to copy their model.

Will the Vanguard advantage disappear? We can only hope for the good of those who have not discovered low cost investing.

Originally posted here;

http://socialize.morningstar.com/NewSocialize/forums/1/2493113/ShowThread.aspx?mrr=1204482905

Chin