As a follow-up to Monday’s post about selecting funds only after choosing an asset allocation, I received this question:
I know you prefer index funds, but what about a low-cost actively managed fund with a great track record? If it fits my asset allocation, should I have it in my portfolio?
Specifically, I’m thinking of Vanguard’s Wellington fund, which appears to consistently outperform Vanguard’s Balanced Index Fund, which has a similar asset allocation.
Using Appropriate Benchmarks
While Wellington does have a similar allocation to Vanguard’s Balanced Index Fund, they’re not precisely the same. Wellington actually should have somewhat higher (before-cost) returns than Vanguard’s Balanced Index Fund because it takes on somewhat higher risks:
- The overall portfolio has a slightly higher stock allocation (66% rather than 60%),
- The stock portion of the portfolio is tilted toward value stocks, and
- The bond portion of the portfolio has significantly more credit risk: Wellington has just 6% of its bonds in Treasury/U.S. agency bonds, whereas the balanced fund has 43% in Treasury/U.S. agency bonds.
To see whether Wellington’s management has added value, it would be best to compare the fund’s results to those of an indexed portfolio with a closer-matching composition. Something like this, perhaps:
- 54% Vanguard Value Index Fund,
- 12% Vanguard Total International Stock Index Fund,
- 28% Vanguard Intermediate-Term Investment Grade Fund,
- 6% of your money market fund/account of choice
How Did Wellington Do?
How does Wellington hold up when compared to such a portfolio?
I don’t know. Because I didn’t check.
Frankly, I’m not all that curious. Checking an actively managed fund’s performance against a relevant benchmark tells you how well the fund did, but it doesn’t tell you much about how well the fund is going to do, which, of course, is what we care about.
The bottom line is that there’s just no way to know whether an actively managed fund’s returns are the result of skill or luck.
So is Wellington a Bad Choice?
I don’t use Wellington in my portfolio. But I wouldn’t say it’s a bad choice by any means. I know several very well-informed investors who use it in their own portfolios. (And I’ve read that John Bogle holds it in his own portfolio.)
Wellington’s expense ratio is just 0.22%, assuming you qualify for Admiral shares. For an actively managed fund, that’s extremely cheap–just ~0.10% higher than what you’d pay for most Vanguard index funds.
If you want to make a bet on active management, you’d be hard-pressed to find a lower-cost bet than Wellington.
Just be careful not to assume that Wellington’s past performance figures (whether absolute returns, or returns as compared to relevant benchmarks) tell you very much about how the fund is going to perform in the future.