VWO - Vanguard ETFs Vs. Vanguard Mutual Funds: The Winners Are...

Summary

• Many investors may be assuming that ETFs will typically be better performers than managed mutual funds of a similar category.
• But some recent research by Morningstar.com may suggest that investors should take a look at Vanguard's managed funds.
• I examined relatively short- and long-term returns from both ETFs and managed funds from Vanguard's lineup.
• I found that for one- and three-year periods, the managed funds were likely a better choice.
• Over a five-year period, there was little difference in returns with ETFs  having a small edge.

Many investors seem convinced that ETFs deliver better returns than actively managed mutual funds. The main drags on mutual funds that are cited appear to be their higher costs as well as poor market timing by jumping in and out of stocks. However, a recent article appeared on Morningstar.com casting some doubt on these assumptions. The article, written by the Vice President of Research for Morningstar, suggests that Vanguard's largest actively managed mutual funds have ranked better in performance than Vanguard's largest unmanaged funds.

The article shows that over the last five years, the performance rankings of Vanguard's managed funds have exceeded the performance rankings of Vanguard's largest unmanaged mutual funds when compared to the performance rankings of all other funds in the same investment category. (Note: I highly recommend you read his article as it is one of the most informative on fund investing I have come across in a long time.)

From a somewhat different perspective, I wanted to directly compare popular Vanguard ETFs with similar Vanguard managed funds, the latter chosen because they seemed to most highly resemble a matching ETF. This would provide a head-to-head comparison of unmanaged ETFs with managed mutual funds of the same ilk. Of course, most Vanguard ETFs have an equivalent class of unmanaged mutual funds with a slightly different structure, but with the exact same portfolio composition, such as Vanguard Growth ETF ( VUG ) being essentially equivalent to the Vanguard Growth Index Admiral Fund ( VIGAX ).

If the proponents of superior ETF performance are correct, ETFs should outperform their managed mutual fund of the same category, even when both funds are chosen from the same fund company, such as Vanguard. (Of course, the ETFs may have other favorable non-performance characteristics which make them more desirable to own than managed funds, such as tax advantages in taxable accounts, but that is a whole different discussion.)

So now let's look at the comparisons I chose to make between the two types of funds, unmanaged ETFs and managed mutual funds.

How I Proceeded

I examined the entire list of Vanguard funds, both ETFs and mutual funds, trying to find managed funds that were most similar to ETFs, not in name necessarily, but in their actual portfolios. For example, Vanguard might classify a fund as a Value fund but actually have a majority of stocks that are considered more in the Blend category.

In some cases, it was difficult to find "matching" Vanguard pairs based on Vanguard's stated fund categories alone. For example, in matching a pair of Growth funds, I wanted to choose a fund that was like VUG but only if it was open to new investors. So, while I could have chosen Vanguard PRIMECAP ( VPMCX ), it is currently closed. Therefore, the comparison would not at this time be actionable if one wanted to buy the fund. I also wanted only funds with at least a five-year track record. As a result, some potentially good choices were eliminated.

The following list shows the eight pairs chosen:

1. Total Stock Market ETF ( VTI ) vs. Dividend Growth Fund ( VDIGX )

2. Total International Stock ETF ( VXUS ) vs. International Value Inv ( VTRIX )

3. Total Bond Mkt ETF ( BND ) vs. Core Bond Inv ( VCORX )

4. Value ETF ( VTV ) vs. Windsor Inv ( VWNDX )

5. Growth ETF ( VUG ) vs. Diversified Equity ( VDEQX )

6. Mid-Cap ETF ( VO ) vs. Strategic Equity Inv ( VSEQX )

7. Small-Cap ETF ( VB ) vs. Strategic Small-Cap Eq Inv ( VSTCX )

8. FTSE Emerging Markets ETF ( VWO ) vs Emerging Mkts Sel Stk Inv ( VMMSX )

Performance Results for Eight Popular Vanguard ETFs vs. Similar Vanguard Managed Funds

Now let's look at how each fund pair performed over one, three, and five year periods:

Fund results shown in bold text indicate a better performance than its "matched" fund. Returns are annualized as of 8-23-22.

Note: "Stated Category" is as defined by Vanguard. However, when examining the above two funds, they both have a predominance of Large Blend stocks and are therefore quite similar.

Note: See the note above. Diversified Equity has a majority of its stocks that would be classified in the Large Growth, not Large Blend, category.

Interpreting These Results

Each of the eight fund comparisons had at least one instance of the managed fund outperforming the unmanaged fund, except in the case of the Emerging Market managed fund.

In six out of eight comparisons, the managed fund outperformed the ETF when the time period examined was one year. When the time period was three years, the results were much more mixed with the managed funds still showing a slight edge. But by five years, the results became highly similar, slightly favoring the ETFs.

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