By Tom Bradley

Last week, Vanguard published an article on active management entitled, 'Success factors for actively managed funds'. While this giant U.S. mutual fund and ETF company is known for being the birth place of indexing, it also has a large portion of its assets in actively managed funds. The article lays out three factors that are necessary for funds to perform better than their indexes over long periods of time – low cost, top talent and patience.

While I whole-heartedly agree with the three, what I found most interesting in the article was the patience part. Vanguard's research showed that for the funds that were successful in beating their target indexes (after-fee fund returns to no-fee indexes), "practically all of them had at least five years where they underperformed through that 15-year period." The article went on to say, "Of those that outperformed, two-thirds of them also had three consecutive years of underperformance. Using the 3-year track record as a reason to get rid of somebody: That would have kicked out two-thirds of the winners along the way."

Vanguard's report is a great reminder that:

  • Superior performance comes in many forms, but none of them are a straight line. Every fund, manager and strategy has periods when returns are poor (or negative), or at least look poor in the context of other funds.
  • Underperformance can persist for a few years if the market is trending is a direction that's not suited to the fund's strategy.
  • And the biggie, investors need to make decisions on funds and managers based on factors beyond short-term performance. The traditional 4P's is a good starting place – people, philosophy, process and (long-term) performance.

In the case of Steadyhand, we've been fortunate enough to have top notch balanced returns (first quartile), but our longer standing clients know that the path to those returns included the Income Fund being hit hard by the credit meltdown in 2008/09, the Equity Fund getting off to a slow start, the Small-Cap Equity trailing a red hot resource market (2009/10) by a large margin and the Global Equity Fund having three consecutive years of underperformance.

Vanguard's report confirms something I feel strongly about – the most enduring inefficiency (opportunity) in the market is time frame. The further an investor can look out, the better.