Wednesday, May 16, 2018

Comparison: Vanguard S&P 500 vs. Three American Funds Mutual Funds

Photo credit: Norwood Themes

Reader M Solve commented on my previous post that three American Funds mutual funds have consistently beat Vanguard's S&P 500 fund since their inception. The comment was that actively managed funds are better than index funds. This flies in the face of extensive research detailed in such books as The Little Book Of Common Sense Investing, so I wanted to check it out. I asked for three American Funds that I could investigate. M Solve suggested AMCPX, AGTHX, and AWSHX.

The Analysis

All of these funds, with the exception of the Vanguard S&P 500 Admiralty shares have been around for a very long time - at least 1976. AWSHX is the oldest fund, starting back in 1952. So all have a substantial track record to look at. But first off, let's examine some facts of each fund.

AMCPX
Return since inception (1967): 11.46%
Expense ratio: 0.68%
Real overall return: 11.46% - 0.68% = 10.78%
Turnover: 21%
Tax-adjusted return since inception: 9.49%
Non-US holdings: 5.4%

AGTHX
Return since inception (1973): 13.53%
Expense ratio: 0.65%
Real overall return: 13.53% - 0.65% = 12.88%
Turnover: 25%
Tax-adjusted return since inception: 11.96%
Non-US holdings: 12.5%

AWSHX
Return since inception (1952): 11.76%
Expense ratio: 0.58%
Real overall return: 11.76% - 0.58% = 11.18%
Turnover: 25%
Tax-adjusted return since inception: 8.67%
Non-US holdings: 6.5%

VFINX
Return since inception (1976): 11.01%
Expense ratio: 0.14%
Real overall return: 11.01% - 0.14% = 10.87%
Turnover: 3%
Tax-adjusted return since inception: 9.53%
Non-US holdings: 0.1%

VFIAX (VFINX Admiralty shares)
Return since inception (2000): 5.98%
Expense ratio: 0.04%
Real overall return: 5.98% - 0.04% = 5.94%
Turnover: 3%
Tax-adjusted return since inception: 5.49%
Non-US holdings: 0.1%


First off, Vanguard Admiralty shares look to have a horrible return, but this is mostly due to the fact that they were created in 2000. The other funds have 25+ additional years of investing to help smooth out the historical returns. Given that VFIAX is exactly the same as VFINX except for the expense ratio, I think we can look solely at VFINX for our comparison.

Expense ratios eat away at fund overall returns. American Funds have an expense ratio of between 0.58% and 0.68%. Compare this to VFINX's 0.14%.

Turnover, given as a percentage of the portfolio that changes each year, in the actively managed funds is, as expected, quite high. Between 21% and 25% of the positions in these funds are bought and sold each year. That creates a potential huge tax bill. This is what Morningstar's tax-adjusted return takes into account. Notice that the tax-adjusted return lops 1% to 2.5% off the total return for the American Fund offerings. (Frequent turnover also creates high trading commissions the fund has to pay, which isn't shown in these figures.)

If we compare the tax-adjusted return of the funds, we see that two of the American Fund offerings,  AMCPX and AWSHX, perform worse than VFINX: 9.49% and 8.67% to Vanguard's 9.53%. That knocks out two of the three contenders.

But to be generous, for the sake of this comparison, let's assume you hold these funds in a tax-advantaged account, such as a Roth IRA. In this case, taxes are not a concern, so it looks like the American Funds offerings are, in fact, better.

But I left out one fact from this analysis so far: the front end load.

What Is A Front End Load?

This is a fee that the mutual fund charges you when you purchase shares. So if a fund has a 10% front end load and you invest $1,000, the company takes $100 and you only get $900 worth of fund shares.

All the American Fund offerings have a 5.75% front end load fee. Vanguard has no front end load fee. None of the funds have back end load fees (fees charged when you sell).

Let's look at how this affects a hypothetical $10,000 investment in each of these funds over 20 years.

Because of the front load fee, $10,000 invested in any of the American Fund offerings results in a net investment of $9,425. The net investment in Vanguard is the full $10,000. Assuming we are in a tax-advantaged account, using the actual return (return minus expense ratio) for these funds (and not the lower tax-adjusted return), after 20 years, we have:

FundInitial InvestmentReturnAmt @ 20 years
AMCPX$9,42510.78%$73,031
AGTHX$9,42512.88%$106,322
AWSHX$9,42511.18%$78,490
VFINX$10,00010.87%$78,756

AMCPX and AWSHX still lose to Vanguard in the long run, even in a tax advantaged account. Only AGTHX beats VFINX over 20 years.

By itself, that is pretty impressive for AGTHX, but it's not the whole story.

What About Geographic Distribution?

The American Funds have significantly more international exposure than the Vanguard funds - up to 100 times more. Not only are these funds subject to foreign market forces, they are also subject to fluctuations in currency exchange rates. This may or may not be acceptable to you.  Here are the percentage foreign holdings of each fund.

FundPercent 
International
Holdings
AMCPX5.4%
AGTHX12.5%
AWSHX6.5%
VFINX0.1%

M Solve's original comment was "All US-focused American Funds have beaten the Vanguard S&P 500 in its lifetime." In fact, the only fund that does beat Vanguard is the one with the most international exposure. With a 12.5% total investment in foreign stocks, I'm not sure I'd call that fund "US-focused."

A higher return typically means a riskier investment. Surprisingly, the American Funds are rated by Morningstar as a below average risk (over a 10 year time frame). As an index fund that mirrors the S&P 500, by definition, VFINX has an average risk rating.


Here's Morningstar's performance graphs.

Click to enlarge
The green line is the S&P 500.

Time Frame Matters

The original commenter specified that these funds consistently beat Vanguard over their lifetime. Here's the value of $10,000 invested in all four mutual funds from 1976, the first year all four funds were in existence:



Wow. I can see where M Solve is coming from. From about 1978 on, the returns seem awful similar to the S&P 500. Knowing that time is the investor's best friend, let's zoom in on that early period and see what was going on. Here's the chart from Aug 31, 1976 to January 1, 1979:



We can see that between December, 1976 and March, 1978, the three American Funds offerings had better performance than both Vanguard and the S&P 500. After that, they started more or less tracking the index.

When looking at long time frames, good performance early on will lead to greater dollar returns decades later due to the power of compounding. I wonder if what we are seeing is simply the natural result of the American Funds offerings having a great couple of initial years? Let's look at some returns not from inception.

Here's a chart for the last 10 years, from January 2008 to January 2018:

That pattern of closely tracking the S&P 500 is present, but the returns are much closer this time. In fact, our previous champion, AGTHX, now is slightly underperforming both the S&P 500 index and VFINX, while AMCPX is the one overperforming.


Or how about the 10 year period from January 2001 to January 2011:


In this period, the winner is AWSHX.

But wait a minute. Every one of those charts overstates the return of the American Funds offerings. Why? Because all these charts assume a starting value of $10,000. As I mentioned before, American Funds charges a 5.75% front load fee, meaning you really aren't starting out with $10,000. You're starting with $9,425! On their website, Morningstar states "Unless otherwise noted, Morningstar does not adjust total returns for sales charges (such as front-end loads, deferred loads, and redemption fees)..."

In fact, this is also stated in the latest Quarterly Fact Sheets from American Funds. Here's the section from the AGTHX fact sheet:


When you exclude that front load fee (NAV line), the returns look great. When you include it (MOP line), not so much. I highlighted two sections - the AGTHX returns INCLUDING the front load fee and the S&P 500 returns over the same time. With one exception, AGTHX lagged the S&P 500 and the one time it didn't, it only beat the index by 0.2%.

Here's the same data from the Vanguard VFINX fact sheet:


Looking at these numbers, we see, when taking into account fees, VFINX beat AGTHX in four of the five time periods. The exception, again, was the 5 year time frame. (AGTHX must have had a decent run during that time. It is possible to outperform the market in the short term.)

This Is Just Market Timing Disguised As Sales Talk

Let's recap what we have discovered: If we look at returns "from inception," all three funds beat the Vanguard fund and the S&P 500. If we look from 2008 to 2018, two of the three underperformed the Vanguard and S&P 500 index and only one, AMCPX, beat them. In the 2001 to 2011 period, AWSHX was the highest returning fund.

Now, I don't know about you, but I don't have a crystal ball, so I can't predict which one, if any, of these funds will beat VFINX in the next 10 year period. I also don't have a time machine that will let me go back in time and invest in these funds when they were first opened.

I do know that when I hear terms like "from inception," I'm immediately suspicious. That seems like a cherry-picked reporting period that gives the fund owners a way to look good and that probably won't hold up to closer examination.

The Bottom Line


I spent several hours pouring over the data and the prospectuses of these funds. I'm still not 100% sure I didn't miss something. For example, I was unable to find any confirmation one way or the other if the stated returns take the expense ratio into account. But even with all that research, the actively managed fund only beats the index if you get lucky and pick the right fund at the right time and hold it for the right length of time.

As John Bogle pointed out decades ago, when you account for the fees and tax consequences of actively managed funds, there is no way they can consistently beat a passive index fund.

We've shown that front load fees greatly reduce the long term return of a fund. We've also shown that, depending on what time period you are looking at, an actively managed fund will lead or lag the index. You can't know if the future will be one of those leading or lagging periods, so why rely on luck when picking an actively managed fund? Why not just invest in the index itself? You may not beat it, but you can be guaranteed you will never underperform it.





Return since inception data, expense ratios, and percent of foreign holdings are taken from the websites of American Funds and Vanguard. Turnover, tax-adjusted return, front load fee information is taken from Morningstar. Data is for American Funds class A shares. Future values calculated with the interest rate calculator here.

0 comments:

Post a Comment