Mutual Funds

Vanguard eyeing smart beta strategies: CEO

Leslie Shaffer | Writer for
Vanguard: This is how you 'own the market'

Vanguard, one of the world's largest mutual fund managers, is closely watching the development of smart beta strategies as a complement to its index fund mainstays, its CEO said.

"It's just another way of doing active management. It's maybe a lower cost way of doing active management and that's what gets our interest," William McNabb, chairman and CEO of Vanguard told CNBC.

Vanguard said it doesn't have plans to introduce a smart beta product any time soon.

(Read more: The latest active investment trend is passive)

Smart beta strategies essentially "soup up" indexes. Rather than creating and index-based portfolio weighted by market capitalization, a smart beta fund would use weightings based on other factors such as earnings, dividends and cash flow.

The oldest and simplest versions used equal-dollar weighting, or putting the same amount of money into every company in an index.

Vanguard, which manages around $2.75 trillion, has built its business on offering extremely low-cost index funds, sometimes with expenses of as little as five basis points.

But McNabb noted around 40 percent of Vanguard's assets are in its active funds.

(Read more: Smart beta: Beating the market with an index fund)

William McNabb, chairman, president and chief executive officer of Vanguard Group
Tim Boyle | Bloomberg | Getty Images

"We think active and passive can work together, but the key point is we believe in low-cost active," McNabb said. "If you have a high-cost active fund, it's a loser's game."

But for now, Vanguard is keeping its focus on its core, passive index funds, with McNabb noting it's "very difficult" for active management to offer value.

"Even in a situation where you see negative news coming from one particular stock or another … analysts don't get that right all the time," McNabb said. "The market tends to move in short bursts. A lot of investors get caught up trying to time that and it's almost impossible to do it," he said.

"Our view is own the market. And over a long period of time, if you own the market at very low cost you'll actually outperform," McNabb said.

(Read more: ETFs woo Mrs. Watanabe with foreign stocks)

Fund performance data don't appear to offer much support for pursuing actively managed funds.

Around 60-69 percent of active fund managers for U.S. stocks underperformed their benchmark indexes over the 12 months to mid-2013, with the result equally bad over three- and five-year horizons, according to the Standard & Poor's Indices Versus Active Funds Scorecard, or Spiva.

Over the previous five years, around 63 percent of global funds, 66 percent of international funds and 75 percent of emerging market funds got beaten by their benchmark indexes, according to the Spiva results.

In addition, the cost difference between Vanguard's index funds and actively managed funds can be large.

(Read more: Are Asia retirees missing out on a key savings tool?)

Vanguard's Total Stock Market Index fund – which last year surpassed Pimco's Total Return fund to become the world's largest – charges a 0.17 percent expense ratio, while its exchange traded fund (ETF) based on the same index has an expense ratio of 0.05 percent.

By comparison, actively managed funds typically charge fees of 1 to 2 percent, in addition to sometimes charging a "sales load" or upfront sales charge to enter the fund, which can run as much as 5 percent of assets.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1