I am one of the most unlikely candidates to be using sports metaphors, but one baseball analogy strikes a chord with me. Before I joined Vanguard, I worked in private equity and raised capital for start-up tech companies. I’ve had experience with the venture capital model of “swinging for the fences”—producing towering home runs or disappointing strikeouts. Think of Babe Ruth. He changed the game by belting 714 career home runs. He struck out almost twice as often—1,330 times.

Swinging for the fences makes sense for hedge funds, which routinely work off a “2 and 20” model—a flat 2% of total asset value as a management fee and an additional 20% of any profits earned. Hitting enough home runs to outweigh the inevitable strikeouts is the only way to justify such fees.

I was recently reminded of the relationship between fees and investing behavior when I looked at the fees charged by some of the leading mutual fund families. If you compare the average expense ratio of Vanguard’s active equity funds with those in the industry, the difference is more than 70 basis points. [1]  To go back to our baseball analogy, competing active managers must take aggressive swings at the ball.

Many active mutual fund managers are big fans of highly concentrated portfolios. There is a widely held sentiment that successful active management requires high “active share”—a statistical measure that simply measures differences in holdings and weightings between a portfolio and its benchmark. When “high-conviction” investing works, it can result in dramatic home runs. However, when it fails the result can be meaningful underperformance or capital loss.

When I watch baseball, the exhilaration of seeing a home run is dwarfed by my disappointment after the much more likely strikeout. What I want is for my team to win when the game is in the books. For my money, I prefer to sit in the nosebleed seats rather than paying for tickets behind home plate. And when it comes to investing, I’ll stick to a low-cost approach with consistent singles and doubles that may add up to scoring runs over time.

 

I’d like to thank Kevin Jestice for his much-appreciated contributions to this piece.

 

[1] Vanguard average active fund expense ratio: 0.27%. Industry average active fund expense ratio: 1.04%. Sources: Vanguard and Lipper, a Thomson Reuters Company. Data as of December 31, 2015.

Notes:

  • All investing is subject to risk, including the possible loss of the money you invest.
  • Costs are one of many factors impacting total returns. There may be other material differences between products that must be considered prior to investing.