Can You Find the Future Winners?
Yesterday, we saw the performance of the Bogle Small Cap Growth Fund (BOGLX), run by John Bogle Jr. (son of the Vanguard founder) and an honorable mention as one of Morningstar's favorite quant funds a few years ago. Out of curiosity, I thought I would check the performance of Morningstar's other favorite picks for quant funds.
Vanguard U.S. Value (VUVLX) The fund currently carries a three-star rating and is characterized as a large-cap value fund. The table presents the evidence for the five- and 10-year periods ending March 18, 2011, comparing the returns to two similar passively managed funds, DFA US Large Cap Value Portfolio (DFLVX) and Vanguard Value Index Fund (VIVAX).
We see that for the five-year period (basically, the period after Morningstar's recommendation) the quant fund underperformed the DFA passively managed fund by 2.1 percent a year and the Vanguard Index fund by 1.6 percent a year. And for the full 10-year period (which includes the period when Morningstar already knew the fund had outperformed for the prior five years), VUVLX underperformed DFLVX by 2 percent a year -- though it did manage to outperform VIVAX by 0.65 percent a year. (Hindsight bias helps.)
It's interesting to note that VUVLX's performance isn't handicapped by high expenses. Its expense ratio, typical of Vanguard's investor friendly approach, was a modest 0.41 percent. DFLVX and VIVAX have expense ratios of 0.28 percent and 0.26 percent, respectively.
Janus INTECH Risk-Managed Growth Fund (JDRAX) The fund, with an expense ratio of 0.9 percent, is a characterized by Morningstar as a large-cap growth fund and currently carries a two-star rating. Morningstar shows a five-year return of 0.96 percent for the period ending March 18, 2011. By comparison, the Vanguard Growth Index Fund (VIGRX), with an expense ratio of just 0.26 percent, returned 3.12 percent. Thus, the fund underperformed an appropriate benchmark by 2.16 percent a year.
It's true that the Janus fund did outperform the Vanguard Index fund in the two prior calendar years, 2004 and 2005, returning 12.1 and 7.2 percent vs. 7.2 and 5.1 percent for the Vanguard Index fund. However, that outperformance was prior to Morningstar identifying them as one of their favorites -- there's that hindsight bias again. And it's insufficient to make up for the underperformance of the past five years.
Bridgeway Large-Cap Growth Fund (BRLGX) The fund, also a large-cap growth fund, with an expense ratio of 0.84 percent, currently carries a two-star rating. For the five-years ending March 18, 2011, it returned 0.43 percent versus the 3.12 percent return of VIGRX. In the two prior calendar years before Morningstar picked the fund, 2004 and 2005, the fund returned 6.8 and 9.3 percent vs. 7.2 and 5.1 percent for the Vanguard fund. Again, not enough outperformance to make up for the underperformance since then.
In summary, once again we see that while it's easy to identify past alpha, it's extremely difficult to identify future alpha. In none of these cases did Morningstar's star ratings predict future winners. We also saw that John Bogle Jr. would have served investors better had he either stuck to engineering, or if he had simply listened to the sage advice from his legendary father.
More on MoneyWatch:
John Bogle: Can His Son Beat the Markets?
How John Bogle Changed the Investing World
The Failure of Quant Funds
5 Reasons to Avoid Variable Annuities
Quest for Alpha: What You Need to Consider When Handling Your Own Investments
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