Proponents of index investing often point to data showing that low-cost broad-market-tracking index funds have generally beaten their actively managed counterpoints over long time horizons, especially on the domestic equity side.
The 2018 performance of my ETF and Mutual Fund Saver portfolios provide yet another data point, albeit a very short-term one. In a market that punished equities, the Saver portfolios that include active mutual funds lost more than the ETF portfolios with similar asset allocations. That illustrates the point, which Russ Kinnel made in this video, that active funds won't necessarily provide a smoother ride in down markets than index funds. Yes, index funds are fully invested, whereas active funds won't necessarily be. But unless an active fund's strategy is inherently defensive--for example, a manager focuses on financially stable, dividend-paying firms--it shouldn't be expected to hold up better than its index-fund counterparts in a weak equity market. Only one of the active funds in the Mutual Fund Saver portfolios, Vanguard Dividend Growth (VDIGX), has such a focus; the rest do not.
The short-term weakness in the Mutual Fund Saver portfolios traces largely to two Oakmark funds, Oakmark Fund (OAKMX) and Oakmark International Small Cap (OAKEX). Those two funds toil in market segments that have been badly out of favor--Oakmark Fund looks for domestic equity stocks that are trading below management's estimate of intrinsic value, while International Small Cap buys smaller-cap value-oriented names overseas. The two funds also managed to underperform their category peers last year. The recent analyst reports for both funds describe their performance patterns as "lumpy"--worst-to-first showings aren't uncommon.
The ETF portfolios held up better than the Mutual Fund Saver portfolios, but they didn't escape losses amid 2018's bruising fourth-quarter equity sell-off. As with the Mutual Fund Saver portfolios, the Aggressive ETF portfolio incurred the biggest losses, whereas the Conservative ETF Saver portfolio held its ground the best of all six portfolios (mutual fund and ETF). That's not surprising given that bonds held up better than stocks last year. The Aggressive ETF Saver portfolio features a 95% equity weighting, whereas the Conservative version features just over 50% of assets in equities with the remainder in bonds.
Aggressive Mutual Fund Saver Portfolio
20% Primecap Odyssey Growth POGRX
20% Oakmark Fund
15% Vanguard Extended Market Index VEXAX
33% Vanguard Total International Stock Index VTIAX
7% Oakmark International Small Cap
5% Metropolitan West Total Return Bond (MWTRX)
2018 Return: -11.28%
Moderate Mutual Fund Saver Portfolio
15% Primecap Odyssey Growth
15% Oakmark Fund
15% Vanguard Dividend Appreciation (VDAIX)
10% Vanguard Extended Market Index
21% Vanguard Total International Index
5% Oakmark International Small Cap
19% Metropolitan West Total Return Bond
2018 Return: -8.05%
Conservative Mutual Fund Saver Portfolio
10% Primecap Odyssey Growth
10% Oakmark Fund
10% Vanguard Dividend Appreciation
7% Vanguard Extended Market Index-
10% Vanguard Total International Index
4% Oakmark International Small Cap
30% Metropolitan West Total Return Bond
7% Fidelity Short-Term Bond (FSHBX)
12% Vanguard Short-Term Inflation-Protected Securities (VTAPX)
2018 Return: -4.85%
Performance Recap: As noted above, the two Oakmark funds in these portfolios posted disappointing performance in 2018. T. Rowe Price International Discovery (PRIDX) , which I replaced with Oakmark International Small Cap when the former closed early last year, performed better than its replacement, an outgrowth of the fact that the T. Rowe fund leans toward the growth side of the style box. (Growth stocks generally bested value last year.) Primecap Odyssey Growth experienced a rare off year relative to its peers, in part because some of its favored biotechnology stocks tumbled. Vanguard Dividend Appreciation was a rare bright spot on the equity side, but it appears in the Conservative and Moderate portfolios only.
The bond holdings in the portfolios were a mixed bag. Metropolitan West Total Return Bond, an intermediate-term bond fund that’s the core fixed income position in all three portfolios, bested its intermediate-term bond peers last year but lagged the Bloomberg Barclays Aggregate Index. Fidelity Short-Term Bond also outperformed its category peers last year, as leaning to the conservative side of its category helped it hold its ground in last year’s bumpy fixed income market.
Portfolio Changes: None. While the Oakmark funds in the portfolio posted steep losses, they should continue to benefit from their disciplined strategies and seasoned management teams. Given the underperformance of those holdings, however, investors who are tracking this or a similar portfolio mix should check to see if their value-oriented and/or international holdings require topping up to bring those positions in line with their targets.
Aggressive ETF Saver Portfolio
50% Vanguard Total Stock Market Index ETF (VTI)
10% Vanguard Small-Cap Value ETF (VBR)
30% Vanguard FTSE Developed Markets ETF (VEA)
5% Vanguard FTSE Emerging Markets ETF (VWO)
5% iShares Core Total USD Bond Market ETF (IUSB)
2018 Return: -9.01%
Moderate ETF Saver Portfolio
47% Vanguard Total Stock Market ETF
8% Vanguard Small-Cap Value ETF
20% Vanguard FTSE Developed Markets ETF
5% Vanguard FTSE Emerging Markets ETF
20% iShares Core Total USD Bond Market Index ETF
2018 Return: -7.17%
Conservative ETF Saver Portfolio
33% Vanguard Total Stock Market ETF
5% Vanguard Small-Cap Value ETF
10% Vanguard FTSE Developed Markets ETF
4% Vanguard FTSE Emerging Markets Index ETF
30% iShares Core Total USD Bond Market Index ETF
11% Vanguard Short-Term Inflation-Protected Securities ETF (VTIP)
7% Vanguard Short-Term Bond ETF (BSV)
2018 Return: -4.32%
Performance Recap: These all-index portfolios performed better than their mutual fund counterparts, as noted above. Vanguard Total Stock Market Index, the largest holding in all three portfolios, lost ground for the year but still managed to perform better than most domestic-equity funds. Small-cap value was the worst-performing square of the Morningstar style box last year, so the portfolios' positions in Vanguard Small-Cap Value was a hindrance. However, it's a small percentage of the portfolio so it didn't inflict undue pain; it also held up substantially better than its small-value peers.
Portfolio Changes: None. However, given the underperformance of small-value and international stocks, investors who track this or a similar portfolio mix might consider rebalancing to boost their positions in those names.
Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.