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Vanguard Index Mutual Funds Versus Vanguard Managed Funds

Go to Part 2: Vanguard Mutual Fund Investment Newsletter >>>>>>>

This two-part article:

1) summarizes a recent research report that compared Vanguard’s passively managed with Vanguard’s actively managed mutual funds (The title of this study by Abel Rodriguez and Edward Tower is “Do Vanguard’s Managed Funds Beat Its Index Funds?” provide links to it below. If you invest in any of Vanguard’s investment fund products, I recommend that you read and understand this study.)

2) discusses an email promotion for an investment newsletter, which claims that it has consistently out-performed and will continue to out-perform Vanguard’s passively managed . (This email solicitation came from Dan Wiener, the editor of The Independent Adviser for Vanguard Investors.)

Use a very low cost, fully passive, and globally diversified investment strategy

Neither this study nor this investment letter email promo has changed my fundamental investment viewpoint, which I summarized in the subheading just above. I strongly advocate to my readers and to financial planning clients that they use an investment fund based strategy that is very low cost, fully passive, and globally diversified. The Rodriguez-Tower study enriched my understanding of Vanguard’s mutual fund offerings and strengthened my convictions. On the contrary, Dan Wiener’s investing newsletter promotion was not terribly enlightening.

Regular readers of my Family Finances articles know that I consistently advocate a very low cost, fully passive, and globally diversified investment strategy for an individual investor’s personal portfolio. Therefore, I will not repeat my reasoning in this article regarding this investment strategy recommendation.

Instead, I will refer you to these articles, which have previously been published on my Family Finance site. In particular, see these articles:

I am also a regular, avid reader of the Journal of Indexes, which you too can read at IndexUniverse.com. Index Universe is a content rich website for index investors, and the Journal of Indexes is one of the few financial publications that I consider to be “must reads.” In its March/April 2008 issue, which was entitled “Active vs. Passive 2.0,” the Journal published an enlightening article entitled: “Do Vanguard’s Managed Funds Beat Its Index Funds?

Do Vanguard’s Managed Funds Beat Its Index Funds?

“Do Vanguard’s Managed Funds Beat Its Index Funds?” was co-written by Abel Rodriguez, now Assistant Professor of Statistics at the University of California Santa Cruz and by Edward Tower Professor of Economics at Duke University. Their paper in the Journal of Indexes was based on Abel Rodriguez’s master’s thesis at Duke, which Professor Tower supervised. This investment research journal article was further developed by Rodriguez and Tower, as Rodriguez worked on his PhD in statistics at Duke.

I was particularly interested in this analysis, because of what I might learn about passive index investing and active management comparisons at the portfolio level, which is what counts in personal investment management. More so than any other investment fund company, The Vanguard Group has offered a very wide array of passive for many years. More recently, they have also offered more actively managed mutual funds, albeit still with very low costs. Additionally and more recently, Vanguard has introduced an array of index ETFs. While actively managed, Vanguard’s managed funds have management expense ratios, which are far below averages for other competitive funds in the mutual fund industry.

Active mutual fund managers simply do not earn their management expense ratios and transactions costs

Briefly, the problem with active management is that, while professional investment managers have been show to demonstrate a modest average level of skill (see in particular, research by Wermer, et. al.), unfortunately their management expense ratios are much higher than their apparent skills. On average, the excessive management expenses of active money managers are over double the value of their incremental performance gain. This, of course, wipes out any incremental performance advantage that professional money managers might provide, if direct portfolio management expenses were all that you considered.

Other factors further complicate the active investment fund cost situation. First, except for choosing very low cost funds there is no reliable way to discern beforehand which manager might out perform another to justify his high fee. Second, mutual fund transactions costs roughly are roughly equal an active mutual fund’s management expense ratio. The more active the fund and the higher the turnover, the greater the transactions costs

Excessive costs and the inability to identify reliably supposedly superior money managers before the fact, creates a compelling financial logic for the individual investor. To improve your net investment performance, you are compelled to move to the low cost end of the mutual fund and ETF spectrum. When you do this, you must also more to the completely passive, indexed end of the product spectrum.

In this process, you soon realize that only Vanguard, Fidelity, and a handful of other investment fund companies offer very low cost investment funds. All the rest of the fund families seem to present their clients with a beat-the-market, 4-star and 5-star fund, superior performance hustle. Of course, securities markets are the great levelers. Some funds will win and others will lose. Over time most winners become losers and vice versa. For decades, this game has been is been very good for the shareholders of the mutual fund companies and not so good for shareholder-investors within these actively managed funds.

Vanguard’s Low Cost Index Mutual Funds and Vanguard’s Managed Funds

This “Do Vanguard’s Managed Funds Beat Its Index Funds?” investment research article offered an opportunity to understand in more detail the trade offs between active and passive mutual fund management within the overall Vanguard product family. To summarize the major conclusions of this study very briefly (It is worth you reading it yourself!), the study generally concluded that over the four year 2003 to 2006:

  • Vanguard’s passive beat Vanguard’s actively managed funds, when there was a relatively close investment style benchmark between passive and active funds. Rodriguez and Tower said “investors would be well-advised to buy instead of managed funds in situations where those funds closely track their index fund baskets.” (p.31)
  • When all passive and actively managed funds were combined into separate portfolios, over these four years, the managed portfolios had “an average out performance of .46%, which was not statistically significant. Much of this differential was explained by the extraordinary performance of the Vanguard International Explorer, Capital Opportunity, and Primecap funds.” (p.29) In essence, this did not prove or disprove the active versus passive question analyzed within the context of Vanguard’s fund offerings. There simply seemed not to be any comparable Vanguard for comparison. Rodriguez and Tower observed that “when managed fund performance is not well explained by a tracking index fund basket, investor may look toward the managed funds.” (p.31)
  • Vanguard managed funds were more risky in general, and their managers did not make prescient style adjustments, as market returns for different investment styles (e.g. growth versus value) fluctuated.
  • Also, quoting this study, “the managed funds on average have expense ratios that are .26% greater than their corresponding tracking index. They also had turnover rates that are 33% greater than the tracking index.” (p.31) It is critical to realize that Vanguard’s managed funds really are very low cost managed funds. Industry averages for actively managed mutual fund management expense ratios are about twice as high or more. The higher the costs and the greater the turnover, the more ground an expensive, high turnover actively managed mutual fund has to cover just to break even with their lower cost, passive index competitors.

To conclude summary of this investment research paper, I would also like to point the reader to some discussions of this paper on Internet forums. Unlike many discussion forums, which often devolve into unproductive emotionalism and bickering, these forum discussions of this research study really are quite informative.

In addition, Professor Tower has participated in these forums, and he used these discussions as a sounding board for ideas and as a means to clarify certain aspects of this study. I recommend these forum conversations to anyone who has or intends to hold a significant portion of his or her personal investment asset portfolio in Vanguard’s , managed funds, and/or ETFs. Use these links to find these forums:

The historical investment performance record of Dan Wiener’s Growth Portfolio

Along with introductory quotations from Paul Merriman and John C. Bogle, the “Do Vanguard’s Managed Funds Beat Its Index Funds?” investment research paper also included an introductory quotation from Dan Wiener. Dan Wiener publishes and promotes an investing newsletter called The Independent Advisor for Vanguard Investors.

Dan Wiener’s quote in the Rodriguez-Tower paper accused Vanguard of lying to its customers, delivering inferior performance with its , and exposing its fund shareholders to the “worst risks of bear markets.” (p.27) When I first read this research paper, I was curious about why the Rodriguez-Tower investment research study even needed to include these comments by Dan Weiner. Also, I wondered why his comments needed to be so incendiary. However, I did not pay much attention to these statements, because they were largely peripheral to the main analysis of the Rodriguez and Tower study.

Near the conclusion of their investing research paper, Rodriguez and Tower briefly addressed the performance of Dan Wiener’s Growth Portfolio. Apparently, Dan Wiener’s mutual fund newsletter has been a strong advocate of using Vanguard’s managed fund offerings. Furthermore, it seems that his newsletter focuses solely upon investing strategies that can be implemented with Vanguard’s passive , actively managed funds, and ETFs. As I understand it, Dan Wiener’s The Independent Advisor for Vanguard Investors investing strategy newsletter does not provide alternative fund recommendations from any other mutual fund companies.

In their study, Rodriguez and Tower stated that Dan Wiener’s Growth Portfolio had demonstrated performance over the prior nine years that outperformed the Wilshire 5000 index by 5.44% annually. Since January of 1992 or over about 16 years, the Growth Portfolio from this personal investing newsletter apparently had delivered average annual returns that were 2.27% greater than the Wilshire 5000 index. In addition, portfolio risk also seemed to have been lower.

Using The Hulbert Financial Digest and the Wilshire 5000 to benchmark Dan Weiner’s historical Growth Portfolio performance

Dan Weiner’s Growth Portfolio performance was not central to the analysis of the Rodriguez and Tower study. Instead, they briefly commented on it, after they had finished the presentation of their study methodology and results, and they were wrapping up their paper. Rodriguez and Tower used separate data that they obtained from The Hulbert Financial Digest, which is an evaluator of investment newsletter performance.

With The Hulbert Financial Digest data, they commented that the 16 years of 2.27% average out-performance of Dan Weiner’s Growth Portfolio was statistically significant at the 13.4% confidence level using a standard t-statistic test. The t-statistic test is a very limited statistical test, and it is used when there are too few data points to use other more robust statistical tests. The t-statistic test simply measures the likelihood of that the average or mean of one small data set is different than the mean of another data set due to something other than simple randomness.

In essence, a 13.4% confidence level implies that there is about a 1 in 12 chance that the difference was purely random rather than likely being due to some other non-random cause or causes. In this case, the non-random cause could be investment skill, lack of comparability of Dan Wiener’s Growth Portfolio and the Wilshire 5000, and/or some other controllable or uncontrollable influence. A t-statistic test makes no judgment about the magnitude or cause of any differences. A t-statistic test compares the averages sparse data sets. A t-statistic test is historical in nature and not predictive.

Someone might be tempted to construe this 13.4% statistical confidence level as evidence of investment skill on the part of Dan Weiner. However, it is also important to point out that standards of statistical proof in investment, economics, and other social sciences research papers almost invariably require a 5% (a 1 in 20 chance) or even 1% (a 1 in 100 chance) confidence interval. In thirty years of reading statistical research papers, I have never seen a peer-reviewed statistical research paper where the author considered that a statistical hypothesis had been proven, when the data did not achieve even a 10% confidence level (or a 1 in 10).

Finally, given the core findings of the Rodriguez-Tower study and Dan Weiner’s apparent Growth Portfolio results, it is interesting to speculate about the source of any out-performance. Since Rodriguez and Tower gave the advantage to Vanguard’s lower cost passive when a more expensive index fund more closely tracked the benchmark, out performance would likely come from another source. One candidate explanation would be to weigh heavily higher growth funds that lacked a passive index counterpart, such as Vanguard Capital Opportunity, International Explorer, and Primecap. Another would be to question whether the Wilshire 5000 was an appropriate benchmark, especially if the source some of these apparently superior returns was international.

I do not know the answer, because the Rodriguez-Tower study only took a cursory look at Dan Weiner’s Growth Portfolio results. Nevertheless, findings of the Rodriguez-Tower study Dan Weiner’s Growth Portfolio results remain anomalous. There seems to be some skill or luck and/or some inappropriate benchmarking going on someplace.

Superior investment performance results, investment costs, taxes, and selective marketing

Despite the previous discussion, let us be gracious and assume that the Dan Wiener finance newsletter performance data are accurate and furthermore let us also assume that that the Wilshire 5000 is an appropriate benchmark for a Growth Stock index. Granting this, then a 2.27% average annual incremental advantage – skill based or luck based – would yield about 43% more in gross assets over 16 years, if the baseline index did not grow over this period. (This ratio would shrink slightly depending upon the growth rate of the benchmark index. If the benchmark index grows 10% annually, then 2.27% incremental growth or 12.27% total annual growth yields a 39% advantage.)

However, since this performance advantage comparison is made with an index without management expenses or taxes. Therefore, the percentage performance advantage above would need to be reduced to the extent that investment expenses and investment taxes were incurred. Therefore, the supposedly superior, skill based performance results of Dan Wiener’s investment letter’s Growth Portfolio may not be all that they might seem.

In addition, the securities and financial services industry has turned selling of superior performance and a “beat the market” strategy into an art form. Unfortunately, millions of individual investors fall into the financial industry’s “we will do better for you” trap. So very few individual investors track carefully their actual results over the long term to see how well or poorly they actually have done relative to a broadly diversified, very low cost, passive index investment strategy. (See: What is the cost to individual investors of sub-optimal portfolio diversification? on The Skilled Investor website.)

One of the tactics employed by financial promoters is to selectively market only those financial products that have demonstrated supposedly superior performance, while downplaying their mediocre funds and sweeping their laggards under the rug. Instead of providing more details about the marketing games here, instead, I will refer you to some articles on our sister website. See these articles and use the links within them to find more articles that discuss selective investment fund marketing and investment luck versus skill:

In the case of Dan Weiner’s Growth Portfolio historical out-performance of the Wilshire 5000 index, there might be a bit of selective marketing going on here. Dan Weiner also has three other portfolios that he promotes in his investment newsletter, “The Independent Advisor for Vanguard Investors.” The Hulbert Financial Digest analyzes investment newsletters, and it tracks the performance of Dan Weiner’s four portfolios. The Hulbert Financial Digest analyzed Dan Wiener’s four investing newsletter portfolios with the portfolios of other investor newletters.

In footnote #15 of their study, Rodriguez and Tower commented on information this information from The Hulbert Financial Digest, saying “Wiener’s Growth Portfolio performed better over the 10 years ending December 2006 on both a risk-adjusted and a non-risk-adjusted basis, that his other three portfolios. The odds that one of his portfolios would perform well due to luck are greater than the odds that one particular portfolio will perform well, so arguably our 13.4% figure in the text overstates his portfolio-picking prowess. The March 2007 edition of The Hulbert Financial Digest lists the Wiener newsletter as fifth out of 24 mutual fund newsletters on the basis of total return and tenth out of 24 on the basis of risk adjusted return.” (p.58)

Does Vanguard discriminate against its passive index fund investors, Dan Weiner suggested? Rodriguez and Tower also addressed Dan Weiner’s accusation that Vanguard in some way discriminated against its managed fund customers to favor its index fund clients. Rodriquez and Tower analyzed this and found no data to support this charge.

Finally, Rodriguez and Tower looked at Dan Weiner’s early 2007 buy, hold, and sell recommendations. They said that “we find those managed funds that he (Weiner) rates buy, hold, and sell have average geometric alphas [presumably skill based performance differences] for the four year period of +1.39 percent, -0.83 percent, and -1.66 percent per year, respectively. Thus, his recommendations are consistent with our alphas.”(p.34) Also, given these numbers, it would seem that Dan Weiner’s recommendations could be consistent with trend extrapolation. In essence, he recommended managed funds that had out-performed over the four years from 2003 to 2006 and advised against Vanguard managed funds that had underperformed during this same period.

Go to Part 2: Vanguard Mutual Fund Investment Newsletter >>>>>>>

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Dan Wiener’s Vanguard Mutual Fund Investment Newsletter Promotion

<<<<<< Go to Part 1: Vanguard Index Mutual Funds Versus Vanguard Managed Funds

In this second part of this two part article, we:

  • discuss an email promoting a mutual fund newsletter that some of my clients forwarded to me,
  • attempt to understand certain rather exceptional investment performance claims for this investment letter,
  • try to reconcile these performance claims with the research paper about Vanguard’s passive and Vanguard’s actively managed mutual funds that was summarized in Part 1,
  • discuss how performance benchmark selection can affect superior performance claims,
  • ask whether Vanguard’s are really for suckers, as Dan Wiener suggests, and
  • question whether Vanguard has an incentive to deceive its customers.

Dan Wiener’s promotional email for his The Independent Adviser for Vanguard Investors mutual fund newsletter

When I first read the Rodriguez and Tower “Do Vanguard’s Managed Funds Beat Its Index Funds?” mutual fund investment research study that was summarized in Part 1, I did not pay very much attention to the few bits about Dan Wiener’s Growth Portfolio. Later, some of my financial planning clients forwarded a recent email newsletter promotional piece from Dan Wiener. The more I read of it, the more intrigued I became. Maybe Dan Wiener had some secret sauce to help my clients beat the market using The Vanguard Group’s mutual funds and ETFs.

In his email promoting his finance newsletter, Dan Wiener says that he knows the secrets to unlocking hidden riches from Vanguard investment funds. He said that these are secrets that “Vanguard will never reveal.” His promo email was quite hefty, and it took some time to read and analyze. This mutual fund newsletter promo email came from Dan Wiener’s email address, and Dan Wiener signed this email twice.

After I read Dan Wiener’s email, I went back and reread the “Do Vanguard’s Managed Funds Beat Its Index Funds?” mutual fund investment research study by Abel Rodriguez and Edward Tower. Then, I reread Dan Wiener’s mutual fund newsletter sales piece in finer detail.

Please note that everything I have written here comes just from my reading of the Rodriguez-Tower research paper, from Dan Wiener’s email, and from certain related posts on the Bogleheads and Vanguard Diehards forums (see links at the bottom of this article). I have not done any additional or independent analysis. I may lack information, and I could be wrong in my interpretations.

Nevertheless, when someone asks me to buy a financial product or service that will allegedly help me to improve my investment performance, I want to understand the underlying facts. I simply expect that written investment product sales documents should have reasonable clarity. In my personal opinion, the Rodriguez-Tower research paper does have reasonable clarity, and Dan Wiener’s investment newsletter email promotion does not.

The aggressive selling of a Vanguard mutual fund newsletter

First, let me summarize the type of email that Dan Wiener sent to my clients and perhaps to many more people. Have you ever found yourself on a colorful and extremely loooooooooooong webpage that pounds an emotionally laden sales message over and over and over from many different angles? That is what this promotional html email from Dan Weiner is like. I printed his email to save myself from a lot of scrolling and to take some written notes. When printed, this investing newsletter email promotion was 16 pages long.

A red border surrounds the promotional copy of Dan Wiener’s email about his finance newsletter. As his sales message progresses, you find that you could get not just 1, but 2, 3, 4, and 5 bonus gift books, if you just sign up NOW! Visions of bonus sets of Ginsu knives filled my head. Ron Popiel might smile about this sales pitch, although the subscription cost of this investment letter substantially exceeds the price points of the products that Ronco sold on TV.

Multicolored text in a wide variety of fonts repeatedly urges you to sign up for this investment newsletter. There are no less than 18 hyperlinks and buttons that each will take you to the same ordering page. On that ordering page, you can select a two-year “Best Value” subscription for $189 or a one-year “Great Value” subscription for $99.95.

Now, everybody needs to make a buck somehow. There are families to feed; mortgages to pay; SUVs to fill with $4.00 per gallon gasoline (not me), etc. Furthermore, this kind of very aggressive promotional email may actually be what is really needed to get people to take action and to place an order for one of these investing newsletters. If the long form of this promotional email is what it takes to sell an investment newsletter, then fine. Presumably Dan Wiener uses an opt-in email list and the people he solicits can just delete his message, if they are not interested.

Nevertheless, despite the sales pressure, it seems to me that the content of any promotional email should reasonably and fairly describe the value of the investment product or service being offered. It also seems to me that the quality of such an email promotion for a financial newsletter might also be indicative of the quality of the actual newsletter to which I am so strongly being urged to subscribe.

My clients were confused my Dan Wiener’s pitch. I looked at it to see if I could clear up the confusion. Maybe I did. Maybe I did not. You decide.

Financial nirvana with Vanguard’s managed investment funds versus the Vanguard passive index fund end of days?

Let’s take a look at the content of this promotional email from Dan Wiener. Almost immediately, in the email you are offered a very stark choice, which says “You can a) do nothing and loose 40% of your money in 2008, or b) make 144% more money than the average Vanguard investor.” Aw shucks. Of course, I will take choice “b”. Where can I sign up? With 18 links and buttons for me to get to Dan Weiner’s ordering page, signing up for The Independent Adviser for Vanguard Investors should be a breeze.

However, to say the least, the copyrighting of this aggressive email is not a model of consistency and clarity. Since I have a belief that the accuracy of a financial newsletter’s promotional email might indicate something about the quality of the financial newsletter itself, I dive in to see if I can figure out this email anyway. Perhaps, things will become crystal clear, as I read more.

The good news is that I already have some information as background. I had already read the “Do Vanguard’s Managed Funds Beat Its Index Funds?” mutual fund study by Rodriguez and Tower, which briefly looked at Dan Wiener’s Growth Portfolio results. (See Part 1 of this two-part article.)

Now, let us look more closely at the claim that you will make 144% more in 2008. Let’s assume that the average Vanguard investor gets a real dollar passive broad market equity index return of maybe 5%. (This might seem a bit low, but let us assume that the US stock market glory days of the 1980s and 1990s are past. In addition, let us keep inflation out to the returns so that my “real dollars” will have constant purchasing power.)

Apparently, by following Dan Wiener’s advice I will make 144% more that 5%, which means about 12.2% annually in real dollar terms. Any sensible investor would salivate over this kind of reliable, long-term stock market return. We are talking about an equity return of over 15% annually with inflation included.

This investment performance sounds very good so far. Let’s assume that I can keep getting this extra 144% return year after year. With compounding, after 10 years I will have a portfolio that is about 1.9 times greater than the average Vanguard investor. After 20 years, it would be 3.6 times greater. After 30 years, it would be 6.9 times greater.

With these superior investment returns, all I need is about a $1,400 portfolio, and I will roughly break even on the $100 annual cost of Dan Weiner’s newsletter. With any larger portfolio, Dan Weiner’s great advice will be pure gravy. This sounds like a great bargain. Where can I sign up? Oh, I see the ordering links and buttons. Thank you. Thank you.

What is the source and precision of the out performance of Dan Wiener’s Growth Portfolio?

But, wait. Now, maybe I should not jump into this too fast, although it sounds very, very appealing. I certainly do not want to lose 40% of my money in 2008, and I sure would instead like to make 144% more than the average Vanguard investor. However, I am not sure where either of these “lose 40%” or “make 144% more” numbers comes from, so I keep reading. I will focus on trying to figure out where the “make 144% more” number comes from, because that is the path that I want to take. I wanna be rich. I want my clients to be even richer.

Well, Dan Wiener’s email has a whole bunch of numbers, and he makes a lot of numerical claims. However, these numbers do not always seem to be consistent. Furthermore, his numbers also seem to be inconsistent with The Hulbert Financial Digest data about Dan Weiner’s Growth Portfolio. These Hulbert numbers were discussed at the end of the “Do Vanguard’s Managed Funds Beat Its Index Funds?” mutual fund study by Abel Rodriguez and Edward Tower.

Reading on into this investing newsletter email, however, I do think that I have figured out where the 144% number came from. I could be wrong, because Dan Wiener’s investor newsletter email promo did not come with any explanatory footnotes. However, one of the email’s sidebars makes three statements above a table of numbers, which were: “How Dan’s Vanguard Midas Touch Has Made His Subscribers Rich,” VANGUARD MADE BETTER!,” and ‘You Can Easily Make 144% More Money This Year.” In that sidebar, Dan Wiener’s investment newsletter promo presents two columns of annual numbers starting in 1991 and going through 2007 for a period of 16 years apparently.

The first column is for the “Average Vanguard Investor” who starts with $100,000 and ends up with $409,061 in 2007. The second column is for “Dan’s Growth Model Portfolio” which also starts at $100,000 and ends up at $996,083 in 2007. Just below these numbers it says “% Advantage 144%; Extra Profit: $587,022″ and just below that there is an ordering hyperlink that says: “Members of Dan Wiener’s service are nine times richer than the average Vanguard investor. Join Dan today.”

Now, unfortunately, I am even more confused. The email said that I could make 144% more than the average Vanguard investor in 2008. Yet, instead, that 144% number appears to be a comparison of cumulative assets after 16 years of compounding. Furthermore, the ordering link says that “Members of Dan Wiener’s service are nine times richer than the average Vanguard investor. Join Dan today.” But the text just above says they have 144% more. You might appreciate why I am starting to have some questions about the precision of the numbers in Dan Wiener’s email.

Gosh, if there is a seeming lack of precision in the investment performance numbers he promotes, then how can I reasonably expect that there will be a high degree of precision is the development of Dan Weiner’s portfolios and newsletters? Things like this just make me nervous. I prefer precise accounting and detailed performance evaluations.

Maybe it is just me, but there has been too much loosey-goosey accounting going on in the investment world recently. Worldcom, Enron, Tyco, and the others went down or under, and their accounting numbers were not completely transparent. I also remember something about the Beardstown Ladies investment club ten or so years ago. They reported substantial market out performance over the years, and they wrote some best selling books. Unfortunately, upon closer examination it seems that they had some trouble doing proper performance accounting, and they actually trailed the S&P 500 by several percent annually for over a decade.

Investment performance discrepancies between Dan Wiener’s mutual fund newsletter promo and the Rodriguez-Tower “Do Vanguard’s Managed Funds Beat Its Index Funds?” mutual fund study

Be “nine times richer than the average Vanguard Investor” in 16 years? “Make 144% more money than you did in 2007?” Have a 144% “advantage” over Vanguard S&P500 index investors, after 16 years? “Lose 40% of your money in 2008.” Well, Dan Wiener’s investment newsletter email promo has not yet cleared things up for me. Perhaps the Rodriguez-Tower study can help me to understand which of these numerical claims might be correct.

Unfortunately, even less clarity emerges. Using data from The Hulbert Financial Digest the Rodriguez-Tower study concluded that Dan Wiener’s 16 year historical Growth Portfolio results provided an average annual excess return of 2.27%, when benchmarked with the broadest US stock market index. Calculated using average annual returns, the cumulative value of this incremental return over 16 years is in the 40% range plus or minus several percent. (The cumulative comparison would depend somewhat on the baseline growth rate.) (Also, just to remind you, 40% is over 100 percentage points lower than Dan Weiner’s claim of making 144% more. Somewhere between Dan Weiner’s numbers and The Hulbert Financial Digest numbers quoted in the Rodriguez-Tower study, we fell off of a pretty big performance cliff!)

In Part 1 of this two-part article, we accepted the possibility of a 2.27% skill based excess performance for Dan Wiener’s Growth Portfolio, when it was compared to the Wilshire 5000 US stock market index. We did not discuss the perhaps reasonable observation that Dan Wiener’s historical Growth Portfolio results might better be compared to a growth stock benchmark. (The technique of using best-fit benchmarking to discern whether investment results are likely to be due to investment fund manager skill versus variations has become widespread in the investment research literature. Rodriguez and Tower apply this technique in the body of their “Do Vanguard’s Managed Funds Beat Its Index Funds?” investment research paper.)

Benchmark, benchmark, who has an appropriate performance benchmark?

Despite having ignored this potential benchmarking problem thus far, Dan Wiener’s aggressive email pitch for his investor newsletter resurrects this topic. In his email, Dan Wiener goes on for a few pages about how Vanguard apparently mistreats its passive index fund clients. Here are various quotes: “Indexing Is (How Can I Say This Nicely?) for … Suckers. Maybe that’s a bit harsh.” [His words are in red lettering, and this is his punctuation.] “If all but the 50 largest stocks continue to gain over the next 15 years, you’d continue to lose money the whole time.” “Index funds are, once again this year, set to dip, then dive.” These statements are followed by a lot of worrisome statements about high-risk growth stocks, high P/E stocks, index dogs, and so on.

Well, maybe the Wilshire 5000 then is not the appropriate benchmark for analyzing Dan Wiener’s historical performance record after all. Maybe the results should be benchmarked against other growth funds of similar style. Dan Wiener’s email pitch was ambiguous about whether his numerical comparisons were with the S&P 500 or Wilshire 5000 indexes. (My guess is that he was using Vanguard’s S & P 500 index fund.)

In their comparison of Vanguard’s passive and managed mutual funds, Rodriquez and Tower used a refined best fit statistical technique to determine which of Vanguard’s passive and actively managed mutual funds were appropriate to compare. This enabled reasonable apples to apples style comparisons. Dan Wiener’s investment newsletter email seems of offer performance comparisons involving apples, oranges, bananas, grapes, kiwis, etc.

In their remarks about Dan Wiener’s Growth Portfolio, Rodriguez and Tower did not apply the same best find benchmarking methodology. They just used numbers from the The Hulbert Financial Digest, which used the Wilshire 5000 as the benchmark index. Well, the Wilshire 5000 encompasses the S&P500. The S & P 500 captures somewhat more that 70% of total US equity market capitalization and is skewed to include the largest companies in terms of market capitalization. The Wilshire 5000 includes just over 5000 US stocks and encompasses almost 100% of U.S. stock market capitalization measured by trading volume. Neither index is skewed toward a growth investment style. Neither index includes any international equities.

What else might be going on with all these contradictory investment performance numbers regarding the historical performance of Dan Wiener’s investment newsletter Growth Portfolio?

After all these claims and this analysis, I have no way of telling whether Dan Weiner really has any “beat-the-market” or “alpha” skill to offer, or whether his newsletter is or is not valuable.

First, what is really an appropriate performance benchmark for Dan Wiener’s Growth Portfolio over 16 years? Has the investment style been consistent or have there been some investment style changes or style drift? If so, have these changes been prescient or not? What Fama-French multifactor model elements might be at play? He calls this his Growth Portfolio. Is it really? What are the large capitalization versus small capitalization implications? What had the US versus International composition been of this growth portfolio? Has there been any successful or unsuccessful market timing going on? Has there been any successful strategic asset allocation going, i.e. shifting any proportions of the portfolio into and out or cash or fixed income assets in a prescient or not so prescient manner?

Without belaboring the history of investment portfolio theory and the associated academic literature, there is little controversy over the value of portfolio diversification. If we assume that one has established a personally risk appropriate allocation between the major financial asset classes of cash, fixed income, and equity securities, we can look at the internal composition of each of these major asset classes separately.

Now, let us look just at the stocks or equities asset class. While the degree of required equities diversification sometime confuses investors, there is a simple rule to follow. The rule is: diversify globally and completely. If one targets a globally diversified personal portfolio that is reasonably proportionate to the market capitalization across the globe, then the composition of your portfolio and the theoretical sweet spot for portfolio mean variance optimization can be expected roughly to coincide.

Frankly, my guess is that all Dan Wiener’s hype about superior performance has much more to do about global diversification and little to do about superior performance or the generation of excess returns or “alpha.” When appropriately benchmarked, I am guessing that these claims of supposedly superior investment performance would just disappear. Despite all Dan Wiener’s claims to the contrary, there is a reasonable possibility that there might be not any superior performance here at all. This might all be due to a lack of diversification on the part of S&P500 index investors. Comparing the performance of a globally diversified multi-capitalization portfolio to a much less diversified US large capitalization portfolio might look like superior performance, when in fact it is really just a failure to diversify globally.

There are reasonable alternate explanations for this. While I do not have access to composition of Dan Weiner’s Growth Portfolio, there is enough chatter on the Bogleheads and Vanguard Diehards Internet forums to reasonably assume that the Growth Portfolio may have had a reasonably large minority allocation to international equities for an extended period. If this is the case, this might be a diversification issue and have nothing to do with truly superior performance in the sense that one more cleverly picks one stock over another or one investment fund over another.

Dan Wiener’s Growth Portfolio could have been much more globally diversified at a time when US stock index investors were staying too close to home and investing too heavily in large capitalization stocks. If so, then that kind of prescience would deserve some respect.

Performance chasing and active management to beat the market is an overly familiar investment sucker’s game. Globally diversifying and getting there earlier than most other US investors is not. Brag about that, and I would be impressed. Select weakly related performance benchmarks to make your investment performance look stronger, and brag about that supposed excess performance, and I am not impressed.

Investors spend far too much money, time, and effort chasing performance to beat the market. Instead, they would be far better off getting their investment strategy in order at the outset. Let me repeat what I said at the beginning of Part 1: Use a very low cost, fully passive, and globally diversified investment strategy!

Marketing superior performance to the public — where is the sucker?

To summarize, these are my observations about Dan Wiener claims of performance superiority:

A) If Dan Wiener claims a nine-fold advantage, I am sorry, but one should not compare the current asset value of one portfolio to the asset value of another 16 years ago.

B) If Dan Wiener claims a 144% advantage over a very low cost, passively managed S & P 500 index fund, then his competing investment strategy should have been to pick the best S&P 500 firms and avoiding the dogs. If he could beat the S and P 500 head to head over 16 years, then that is really something that he should be proud of. The SPIVA data shows that the longer active funds try beating the passive S&P500 index the more dismal the record of actively managed S&P 500 mutual funds becomes. If he claims a 144% advantage without clarifying that he is using an apples to oranges comparison, then this is not so appealing. If he accuses Vanguard of lying over the matter, then this is far less attractive. Since he is not managing his own mutual funds to produce a 144% advantage, but he apparently is just substituting other Vanguard funds into a portfolio, then it sounds like he is biting the hand that feeds him. In my opinion, that is just rude.

C) If Dan Wiener claims a 16 year 144% performance advantage and then states that two Duke University professors “conclude that my way of investing in Vanguard funds has an 87% probability to continue to outperform for the foreseeable future,” then I seems odd that he does not also mention that that study’s numbers implied a far lesser 16 year “positive alpha “advantage of around 40% or so. Why this 100% percentage point difference? From what I can tell, but cannot be sure of from the confusing information presented in this mutual fund newsletter promo, this may be primarily because the performance comparison was with the S & P 500 versus the Wilshire 5000. Furthermore, he fails to mention that those professors made absolutely no predictive statements. (See below.) Finally, he fails to mention that in footnote 15 Rodriquez and Tower said that any apparent skill level was probably below 87%.

Frankly, this kind of selective marketing of supposedly superior performance to sell investment and other financial products and services is practically an epidemic in the financial services industry. (See for example, “How Morningstar Ratings for mutual funds are used as a marketing tool” on The Skilled Investor website.) Most often such superior performance promotional claims are simply due to market volatility, randomness, and inappropriate performance benchmark marketing. With Dan Wiener’s investor newsletter email, the exact location of the performance benchmarking bull’s eye still remains elusive.

Does The Vanguard Group keep its mutual fund and ETF investors in the dark? Does Vanguard lie to its customers?

Moving on through this investor newsletter email promo from Dan Wiener, we next are told that all we need to do is to sign up for his newsletter and Dan Wiener will “reveal 19 Vanguard secrets” … “Unfortunately, most Vanguard investors won’t have a say in the matter. Vanguard won’t give them or you the choice. They won’t tell you what to do, no matter how bad things get in 2008.”

Now, I do not have much of a clue about what Dan Wiener is talking about. Is he imposing an advisory obligation on Vanguard? While Vanguard more recently has offered some investment advisory services for a fee, Vanguard is a mutual fund company. Like all the rest of the mutual fund industry, Vanguard offers an array of funds to choose from. It has no obligation to tell you which is best or to tell you what to do. You do that yourself or you hire (hopefully an objective) financial advisor or investment counselor to help you.

In a sense, individual investors are lucky that that Vanguard does not make choices for them, given the mutual fund industry’s history of high costs and performance hyping. Vanguard is one of the few companies that refuses to hype 4-star and 5-star funds and use misleading performance graphs in its advertising. (See the bottom of Part 2 of this article: “How to lie with statistics: Investment performance charts” on The Skilled Investor website.)

I probably will never learn the secrets that Dan Wiener knows and that Vanguard is withholding from me. He really lost me when he had some apparent difficulties with consistent math. When he talks about Vanguard’s secrets, is he talking about Vanguard’s managed funds? Vanguard’s ETFs? Mutual funds that Vanguard closed to new investors due to excessive capital inflows? It is all on Vanguard’s websites. Go look. If you want the opinions of other Vanguard investors, take a look at the Bogleheads Investment Forum and Vanguard Diehards forum.

I understand business, economics, and the capitalist system reasonably well. I do not believe much in financial cabals, although concerns about monopolies and oligopolies seem quite real to me. Self interest drives capitalism. However, in a financial industry that often exhibits borderline marketing and sales practices toward individual investors, over the years I have reached the conclusion that Vanguard is one of the good guys. I also reached the conclusion that John C. Bogle is one of the honest men of the industry. Vanguard is out to make a profit — a reasonable profit. That is much more than I can say about many other parts of the financial services industry. (See: “Have You Given Enough to the Financial Services Industry?” on The Skilled Investor’s Personal Finance Blog.)

While much of the rest of the industry is pushing overly costly investment products, Vanguard developed the low cost index mutual fund market and has added managed funds, ETFs, and a variety of other services. More so than other financial services companies, individual investors have to seek out Vanguard’s products, because Vanguard does not fund massive corps of heavily commissioned “producer employees” and third sales “financial advisor” agents like the retail arms of the investment bank wirehouses, insurance companies, and other financial firms do. Very often, supposedly objective financial advisors and investment counselors will not recommend Vanguard’s fund products, because they can make a great deal more money from you by selling you expensive investment products that are good for them, but bad for you. (See: “Pay less to get more” on The Skilled Investor website.)

So when I read an aggressive email promoting an investment newsletter that can’t seem to do math and benchmark comparisons consistently and that feels it is has to disparage the ethics of a company like Vanguard, well then that kind of newsletter marketing message just falls a bit flat for me. If Dan Wiener truly has some skills, at least I would be far more interested in subscribing to his investing newsletter, if he clearly described how his services were complementary to Vanguard’s and were a valuable addition to the already very valuable offerings provided by Vanguard.

The “Do Vanguard’s Managed Funds Beat Its Index Funds?” research paper – a “liberal” interpretation

Weary reader: I promise that I am near the end of this commentary. However there is one more issue that is worth covering. In addition to disparaging Vanguard’s ethics, Dan Wiener seems to a bit of difficulty accurately describing what the Rodriquez-Tower study said.

Quoting from another sidebar in Dan Wiener’s email, Dan Wiener said: “Dan’s strategy is simple, yet powerfully effective. His deep knowledge of Vanguard, his investigative insights, and his investment results prompted two Duke professors to study his methods … under a microscope.” “The study’s conclusion: The probability that [Wiener's] Growth portfolio could have outperformed by such a wide margin because of luck rather than skill is only 13.4%”

Well, first I was unable to find any mention from Rodriguez or Tower that they conducted their study due to Dan Wiener’s “deep knowledge of Vanguard, his investigative insights, and his investment results.” I found nothing in the “Do Vanguard’s Managed Funds Beat Its Index Funds?” research paper that credits him. He was not on the credits for this paper that Professor Tower provided in the forum discussions.

The Rodriguez-Tower investment research paper only briefly looked Dan Weiner’s Growth Portfolio record at the end. Rodriguez and Tower undercut this performance claim through their reference to The Hulbert Financial Digest, ratings of his four funds (See footnote #15 in the Rodriguez-Tower paper.) Furthermore, their analysis discredits Dan Wiener’s claim of Vanguard’s bias and favoritism toward its passive index mutual over its managed mutual funds.

Interestingly, Dan Wiener again seems to treat facts somewhat cavalierly. In the main body of his promotional email text, he says: “Turns out, everyone (except my members and me) is wrong about indexing. The two Duke University professors I referenced earlier conclude that my way of investing in Vanguard funds has an 87% probability to continue to outperform for the foreseeable future.” (Note that the underlining was Dan Wiener’s and not mine.)

Dan Wiener continues, “I already knew this, of course, except for the “87%” figure. I think that number is much higher. Anyway, it’s nice to have a comprehensive study conducted by a major university confirm what members of my service knew the day they joined.”

These statements is stunning to me. Rodriguez and Tower performed a simple statistical test on historical data about the performance record of Dan Weiner’s Growth Porfolio. They made no prediction. Investment studies are always historical and never predictive. The only data available is historical. In general, professors do research, and rarely are they so foolish as to attempt to predict the fundamentally unknowable future. Objective statistical research cannot be predictive, because it simply does not have any data points from the future.

Should I believe Dan Wiener’s superior performance predictions or his small print?

To sell his newsletter, Dan Wiener claims in his email that his special strategy has at least and 87% probability of outperforming Vanguard’s into the foreseeable future. He says directly that the real probability is much higher that 87%. Sounds like money in the bank for his mutual fund newsletter subscribers.

To make this claim, which he underlines in his aggressive email promotional text, Dan Wiener dons the endorsement mantle of two Duke University professors. However, in reality, these professors have undercut his claims, and they have provided no endorsements. Dan Wiener blithely converts what is simply an historical research statistic into a prediction which is supported by Duke University professors. Then, he claims even greater skill than the historical statistics that were reported. Dan Wiener ignores The Hulbert Financial Digest, data completely.

With such an endorsement from Duke University professors and with Dan Wieners prediction that he is almost certain to outperform Vanguards , then maybe I will change my mind and sign up for Dan Wiener’s mutual fund investment newsletter. Therefore, I again click on one of his plentiful ordering links and buttons to get to the ordering page.

As you already understand from this article, I can be a cautious sort of fellow. Therefore, I decide to read the entire ordering page in detail before ordering. At the bottom the order sheet, the small print says “This is a solicitation for The Independent Adviser for Vanguard Investors, a monthly general interest newsletter which is not liable for the suitability or future investment performance of any securities or strategies discussed. Historical investment return examples given are hypothetical, and not to be taken as representative of any individual’s actual trading experience.”

WTF??? Why does the legal small print say quite the opposite of Dan Wiener’s financial newsletter email promo? He says he thinks that his success rate will be “much higher” than the 87% probability of future success that was supposedly bestowed by these two Duke University professors. Which of these two choices should I believe?

Well, I guess that am going to keep my $100. If Dan Wiener a) cannot seem to offer consistent numbers, b) feels the need to bite Vanguard’s hand rather than stand solely on his own merits, c) does not seem to interpret carefully an investment research study that mentions him, and d) contradicts his own performance projections, then maybe I am not really interested in knowing what is inside of his investment letter after all.

Also, I have decided that will also keep my respect for Vanguard. In addition, I will also keep my respect for disciplined academic investment research. It seems to me that I can find a wealth of objectivity about investing in the academic research literature. However, whenever someone in the financial services industry stands to earn a buck off of me or my clients, the facts often very quickly begin to lose their sharpness. The quality of investment information is often very low when it comes from a source that is simultaneously reaching into my wallet or into the wallets of my financial planning clients.

<<<<<< Go to Part 1: Vanguard Index Mutual Funds Versus Vanguard Managed Funds

Bogleheads and Vanguard Diehards forum discussions about Dan Wiener’s mutual fund newsletter

By the way, if you want to read some forum discussions about Dan Wiener’s mutual fund newsletter, here are some links:

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