In Search Of Low-Cost Active Management Mutual Funds

In the past, I’ve written about five of the most expensive mutual funds on Wall Street. These mutual funds all had expense ratios greater than 3%, and none of them had long-term returns that justified these management costs.

But let’s look at the other end of the cost spectrum. Is it possible to get an actively-managed mutual fund at costs similar to that of index funds?

Why Invest In Actively-Managed Funds?

I personally do not invest in actively-managed mutual funds, and I don’t recommend that you start investing in active mutual funds. However, some people feel compelled to hire a fund manager to try to beat the market. On average, actively-managed mutual funds underperform index funds, but every year, there is some percentage of actively-managed mutual funds that will beat the market. I would attribute a fund beating the market in a given year primarily to luck, but others would attribute it to skill.

But if you’re going to buy an actively-managed mutual fund, you might as well pick one that has the lowest costs.

Some people think that the massive influx of money in index funds is distorting the stock market. They believe that with less and less money in actively-managed mutual funds, it will become easier to beat the market. I disagree with this hypothesis, but let’s say that were the case. In such a scenario, I would pick the actively-managed fund that had the lowest costs, so that there is a lower hurdle to beat the market. If a fund only charges 0.2% of assets, then the hurdle required to beat the market is lower than if a competing fund charges 1.0% of assets.

Search Strategy For Low-Cost Active Management Mutual Funds

I initially started my search for low-cost actively-managed funds with Fidelity, which is where I do most of my investing.

However, I found that almost every low-cost actively-managed mutual fund was managed by Vanguard. If you want to invest in an actively-managed mutual fund, I would recommend opening an account with Vanguard to do so. If I were to buy Vanguard mutual funds at Fidelity, I would have to pay a transaction fee. There is no transaction fee to buy Vanguard mutual funds at Vanguard.

So I went over to Vanguard’s website and searched through their mutual funds. Even though they are legendary for their index fund offerings, they also offer many actively-managed mutual funds as well. The expenses Vanguard charges for their actively-managed funds are well below the industry average, and are often similar to what they charged for index funds just 10-15 years ago.

Here are five Vanguard actively-managed mutual funds that have expense ratios comparable to index funds.

Bond Funds: Vanguard Intermediate-Term Treasury Fund Admiral Shares (VFIUX)

There are several actively-managed bond funds at Vanguard. Each of these funds specializes in a certain type of maturity bonds (short-term, intermediate-term, or long-term). One example is the Vanguard Intermediate-Term Treasury Fund Admiral Shares (VFIUX), which invests in intermediate-term Treasures (5-10 years). The expense ratio for the fund is only 0.10%, while the Vanguard Total Bond Index Fund has an expense ratio of 0.05%.

There is a $50,000 minimum on VFIUX; otherwise, you have to invest in the Investor Shares version of the fund, VFITX, which has an expense ratio of 0.20% ($3,000 minimum). Unfortunately, VFIUX has underperformed its benchmark over the past 10 years (4.62% vs. 5.19%).

Balanced (Stock and Bond) Funds: Vanguard Wellesley Income Fund Admiral Shares (VWIAX)

For investors wanting a single fund that holds both stocks and bonds, one option at Vanguard is the Vanguard Wellesley Income Fund Admiral Shares (VWIAX). It holds approximately one-third of its portfolio and stocks and two-thirds of its portfolio in bonds. I think this allocation is too-low if it were to be used for your entire portfolio, since I recommend at least 50% stocks even in retirement according to the Trinity University study, and others recommend an even higher equity allocation in retirement.

The expense ratio for VWIAX is 0.15% for the Admiral shares ($50,000 minimum); otherwise, you’ll have to pay 0.22% for the Investor shares using VWINX ($3,000 minimum). VWIAX has beaten its benchmark index over the past 10 years (6.91% vs. 6.05%).

Domestic Stock Funds: Vanguard Equity Income Admiral Shares (VEIRX)

The Vanguard Equity Income Admiral Shares (VEIRX) focuses on large-cap value stocks. The expense ratio is 0.17% for the Admiral shares ($50,000 minimum); otherwise, you’ll have to pay 0.26% for the Investor Shares using VEIPX ($3,000 minimum). VEIRX has beaten its benchmark index over the past 10 years (7.42% vs. 7.04%).

Domestic Stock Funds: Vanguard Windsor Fund Admiral Shares (VWNEX)

The Vanguard Windsor Fund Admiral Shares (VWNEX) has been around since 1958 and currently manages $18.7 billion dollars.  The expense ratio is 0.20% if you can meet the $50,000 minimum for the Admiral shares; there are also Investor shares (VWNDX, $3,000 minimum) that have an expense ratio of 0.30%. VWNEX has done slightly better than its benchmark index over the past 10 years (5.69% vs. 5.57%).

International Stock Funds: Vanguard Global Minimum Volatility Fund Admiral Shares (VMNVX)

Vanguard Global Minimum Volatility Fund Admiral Shares (VMNVX) is an international stock fund that seeks to “minimize volatility relative to the global equity market.” It’s a relatively new fund, only being around since 2013, and currently manages $2.1 billion dollars. Its expense ratio is 0.17%, while the Investor shares ($3,000 minimum) has an expense ratio of 0.25%. Vanguard’s international index fund, VTIPX, has an expense ratio of 0.11%, so you are not paying much for a professional fund manager. The fund has only been around since December 2013, but thus far, it has beaten its benchmark index (11.45% vs. 9.55%).

One Caveat When Buying Actively-Managed Index Funds

Because actively-managed funds typically have high turnover ratios, these funds will not be as tax-efficient as their index fund counterparts. This tax-inefficiency is worse for investors in higher tax brackets. If you are going to include one of these funds into your account, consider putting them in a tax-advantaged account such as a Roth IRA.

The Zero-Cost Actively-Managed “Mutual Fund”

An alternative way to get access to a fund manager without the high costs is to buy shares of a conglomerate such as Berkshire Hathaway. Berkshire Hathaway’s portfolio is concentrated in certain sectors such as insurance, but you are able to get the expertise of Warren Buffett, Charlie Munger, and their proteges at no management cost to you. The fund also does not pay dividends, so it is highly tax-efficient for doctors and other high-income professionals. You also get access to the Berkshire Hathaway Annual Meeting in Omaha.

Conclusion

To summarize, I’m not a fan of actively-managed funds — I prefer a simple three-fund index portfolio. But if you must use an actively-managed mutual fund, then Vanguard is the place to buy those types of funds.

What do you think? Do you own any actively-managed mutual funds? What are their expense ratios?