Active fund management can be more complex and less transparent than indexing. So you need to apply a rigorous assessment process when you're adding active fund manager satellites to an index core.
While in Australia Vanguard is probably best known as an index provider, when we started in the US back in 1975 our initial line-up consisted of 11 active funds. And today more than a third of the A$5.4 trillion assets we look after for investors around the world are actively managed.
So I'd like to share some of the insights we've picked up over the years on how to manage active funds successfully.
At Vanguard, whether we're commissioning an external manager or utilising internal expertise, there are three areas that we believe hold the key to improving the odds of active management success—talent, patience and cost.
First up I'd like to talk about the importance of talent when selecting an active fund manager for the long term.
Jack Bogle's four Ps
Over the years there have been many academic studies proposing shortcuts for identifying a skilled active manager.
But much of the industry has settled on using some variation of the ‘four Ps' cited by Vanguard founder Jack Bogle all the way back in 1984—people, philosophy, portfolio and performance.
At Vanguard, we have developed Mr Bogle's principles into a framework focusing on four key qualitative drivers of performance that lead to outcomes in two key areas.
So when you're evaluating a fund manager it's important to ask the right questions in each area.
- Is there a culture of investment excellence and stewardship?
- Is the firm financially stable and viable?
- Are the key investors experienced, talented, and passionate?
- Do they have the courage to have a differentiated view but the humility to correct a mistake?
- Philosophy - Does the firm have a clear philosophy on how it seeks to add value that is universally shared by the investment personnel?
- Does the manager have a competitive advantage enabling it to execute the process well and consistently over time?
-Can the process be effectively implemented given the assets under management?
- Do the historical portfolio holdings and characteristics align with the manager's philosophy and process?
- Are the drivers of historical performance logical and aligned with processes?
- Are the drivers of returns sustainable over the long term?
Activating active in Australia
We apply this philosophy to a range of managers and investment styles, including fundamental active equity, fundamental active fixed income, quantitative active fixed income and quantitative active equity.
Sometimes we tap into the expertise of external managers that promote the Vanguard way of investing; one that emphasises low costs and a long-term perspective.
Other times our search ends within our own investment management teams—like the Vanguard Quantitative Equity Group, which is managing our new low-cost, high-quality active capabilities here in Australia using a rigorous, disciplined process honed over the past 25 years.
It's a very different style of active management than the ‘stock picking' approach traditionally available to Australian investors.
You can read more about the keys to improving the odds of active management success in our updated research paper.
Next time I'll share more about the second key element in improving the odds of active management success — patience.