GMO versus Vanguard: Assessing the Performance of
Comparable Funds
A Note Prepared for the Bogleheads 9 Meeting in Philadelphia,
October 2010
Edward Tower1
Professor of Economics at Duke University
Visiting Professor at Chulalongkorn University
Tower@econ.duke.edu
October 2010
Abstract
GMO is a well known mutual fund company that serves wealthy clients. The minimum investment for a
mutual fund account is 10 million dollars. GMO’s web site is a font of useful and entertaining
information. Should the Vanguard investor who can’t afford to invest with GMO be envious of the
wealthy who have access to GMO funds? This paper asks whether the GMO funds that have similar
Vanguard counterparts over-return or under-return their Vanguard counterparts, and by how much.
Some of the Vanguard counterparts are indexed. Thus, this paper also provides evidence on whether
stock pickers can beat indexers.
Introduction
John Bogle (2005), the founder of Vanguard, has argued “In investing you get what you don’t pay for.”
This is part of his argument for investing in low cost index funds. Unquestionably , if managed funds
charge sufficiently high expenses they will underperform indexed funds. But what of managed mutual
funds with reasonably low expenses? One company that has relatively low expenses is GMO.2 It hosts a
web site that posts useful information, including predicted real returns for various asset classes and
Jeremy Grantham’s quarterly letters. However, the minimum investment for a mutual fund account is
10 million dollars ( although four of GMO’s funds are available through Schwab (2000) with a minimum
investment of 1 million, and GMO is the sub-advisor for some funds issued by other companies). Tower
and Zheng (2008), building on Bernstein (1999 & 2000), conclude that mutual fund families which treat
1
2
Thanks go to Charlie Becker, Rick Ferri, and Steve Thorpe for helpful comments.
For example GMUEX, GMO’s Core equity III has an expense ratio of 0.46 per year, while Vanguard’s 500 Index
fund, a roughly comparable fund, has an expense ratio of 0.18% per year.
1
their wealthiest customers to low expense ratios and do not have front-end or back-end loads and have
low turnover tend to produce higher returns for clients even before expenses and loads are subtracted
from mutual fund performance. They argue that these are mutual fund families which cater to richer
clients, who monitor performance more closely. Therefore, competitive pressures force these
companies to manage their funds to yield better returns to their clients. GMO has relatively low
expenses and its mutual funds do not have loads. Thus there is a presumption that their funds will
perform well relative to Vanguard’s. This is enhanced by GMO’s claims on its web page that its funds are
likely to outperform indexes. For an investor what is more relevant is whether GMO’s funds perform
well relative to similar funds produced by a low cost well known provider, rather than relative to
indexes. Thus, it is useful to explore how well GMO’s funds perform relative to Vanguard’s funds. That is
what this paper does.
GMO’s Claims
The seven year asset class forecasts on GMO’s web site through July 2010 provide estimates of the value
added by GMO’s active management for various asset classes. As of July 31, 2010 these were: US
equities: 1.8%/year, international equities: 2.3%, emerging equities: 3.7%, US government bonds and
inflation protected Treasuries: 0.9%, and US short term government bonds: 1.4%. Unlike all previous
reports, the August 31, 2010 report does not repeat the claim of value added by GMO’s active
management. The web site does not explain why GMO stopped reporting this. I wonder if it reflects a
loss of confidence based on recent performance? Let’s explore whether this is a reasonable hypothesis.
Methodology
Morningstar’s web page provides returns for mutual funds over 1, 3, 5 and 10 year periods. The study
uses these data to compare Vanguard’s indexed mutual funds with their GMO counterparts. The
comparison is shown in Table 1. The study used only those funds that judging from the name and
description on the Morningstar Principia disks had a similar style to a Vanguard fund. An alternative
approach would be to compare returns with Fama French constant style indexes. We leave that to a
future paper. Here we ask the question “Would Vanguard investors on average have received higher
returns moving from Vanguard funds to GMO funds with similar descriptions, and similar Morningstar
style box descriptions.
We supplement these calculations using the data on Morningstar’s Principia disk, to obtain return
differentials starting at the beginning of 2003 through the end of 2009. The 2009 figures were drawn
from Yahoo, since I was working from an old Principia disk. Yahoo is less reliable than Morningstar.
Style adjustments were performed in an earlier study (Tower and Zheng, 2008). We looked at the
equally weighted portfolio of funds investing in US assets from 1994-2004 inclusive. Using Vanguard’s
minimum expense class, not adjusting for risk, we found that GMO beat its corresponding index basket
by 0.74 % per year, while Vanguard beat its corresponding basket of indexes by 0.20 % per year. Risk
adjusted the two numbers were 1.10 % per year and 0.37 % per year. Again GMO beat Vanguard.
2
Results
Exhibit 1 reports that both the median and average Vanguard funds had lower returns than their GMO
counterparts over the entire ten year period through September 23, 2010. The returns are annualized
geometric averages. The average excess return of the GMO funds is 1.17 % per year. However, recent
shorter periods are dramatically different. Over the most recent five year period, Vanguard’s average
excess return is 1.81 %/year. Over the most recent 3 year period its excess return is 0.29%/year. Over
the most recent year its excess return is 0.88 %/year. Median values have the same sign pattern.
Thus while over ten years, GMO’s funds that correspond to Vanguard funds have out-returned
Vanguard’s funds, the GMO advantage has become negative in recent years. On average GMO’s claim of
the superiority of its managed funds to index performance has carried over to outperforming Vanguard
funds during the first half of the most recent ten year period. Over the second half it has not.
These calculations are supplemented by Exhibits 2 and 3. Exhibit 2, shows average return differentials
from the start of the year indicated to the end of 2009, calculated in the same way as in Exhibit 1.3
Vanguard under-returned from the beginning of 2000, 2001, and 2002. It had an excess return from all
other start dates, beginning in 1993. There are fewer funds in the earlier years however. The trend line
shows an increase in the average differential return favoring vanguard. This slope is highly influenced by
the outperformance of Vanguard in 2009.
Note that Vanguard way out-returned in 1998 and 1999, when growth trounced value in the US stock
market.
Vanguard replaced GMO as co-manager of some of its funds with its own analysts, indicating that
Vanguard feels that it can at least match GMO’s judgments after expenses.
Vanguard Group, the second-biggest US mutual-fund company, dropped the Boston-based GMO
LLC investment firm run by Jeremy Grantham as co-manager of three domestic stock funds that
lagged behind peers in the past year.
GMO was removed from the $10.5 billion Explorer, the $975 million Vanguard US Value, and the
$695 million VVIF-Small Company Growth Portfolio, Vanguard said yesterday. Vanguard, based
in Valley Forge, Pa., replaced the Grantham firm with its own quantitative equity group, which
uses mathematical models to pick stocks. (Boston Globe, 2008).
This study has not looked at GMO’s funds that are less closely matched by Vanguard’s funds. It has not
examined GMO’s asset class predictions. On that see Tower (2010a). Nor has it looked at GMO’s
3
The corresponding fund for GMSUX is VISVX.
3
Benchmark-Free Allocation Fund, which can substantially alter its style as different styles become over
or undervalued. On that see Tower (2010b). This study should be interpreted as only comparing the
stock and bond selecting prowess of GMO with the stock selection mechanism of Vanguard’s
corresponding funds, be they managed or indexed. The Vanguard share class used for these
comparisons is the investor class. The Admiral and Institutional share classes have lower expense ratios
as do Vanguard’s ETFs. Had we used those, we would have shifted the excess return differential in favor
of Vanguard.
Should we be surprised at the fall in the advantage of GMO? Our result is consistent with that of Barras,
Scaillet and Wermers (2008) who report a decline in the performance of stock pickers relative to
indexers over time (through 2006). It is also consistent with the same result found for Vanguard’s
managed versus index funds and fundamentally indexed funds versus Vanguard’s indexed funds
(Tower, 2009 a &b).
Perhaps the current paper’s result that GMO’s relative performance has declined reflects an increase in
the efficiency of the stock market. It may reflect an increase in the efficiency of Vanguard relative to
GMO. It may reflect different Fama-French styles. The sample is small and the change is not significant
at conventional levels, so the change may be random.
I draw two conclusions from these results. First, there is no compelling reason to be confident that
GMO’s stock and bond selecting prowess will exceed Vanguard’s by enough in the future to make up
for the somewhat higher expenses of GMO. This is especially true for Vanguard investors who are
eligible to invest in Vanguard’s Admiral share class. Second, the high variance in the annual return
differential likely reflects differences in style between funds that have similar names. An investor
should investigate the composition of the corresponding funds before deciding which to hold.
References
Barras, L.,O. Scaillet, and R. R. Wermers. 2008: False Discoveries in Mutual Fund performance:
Measuring Luck in Estimated Alphas. College Park: University of Maryland, Smith School
Research Paper Series, RHS 06-043.
Bernstein, W.J. 1999. The slippery slope of fund expenses. Efficient frontier: An online journal of
paractical asset allocation. July. http://www.efficientfrontier.com/ef/799/index799.htm
Bernstein, W.J. 2000. The slippery slope of fund expenses, part II. Efficient frontier. Winter.
http://www.efficientfrontier.com/ef/100/exp100.htm.
Bogle, John C. 2005. “In Investing, You Get What You Don’t Pay For.”Keynote speech by John C.
Bogle, at The World Money Show.Orlando, Florida February 2, 2005.
http://johncbogle.com/speeches/JCB_MS0205.pdf
4
Boston Globe. 2008.”Vanguard drops GMO as funds co-manager.”
http://www.boston.com/business/markets/articles/2008/02/27/vanguard_drops_gmo_a
s_funds_co_manager/
GMO web page. 2010. http://www.gmo.com/America/MyHome/default
Morningstar . 2010. “Investor Resources.” http://www.morningstar.com/Cover/Funds.aspx
dollars
Schwab website. 2000. http://www.allbusiness.com/economy-economic-indicators/economicnews/6459905-1.html.
Tower, Edward and Wei Zheng. 2008. “Ranking Mutual Fund Families: Maximum Loads and
Minimum Expenses as Markers for Moral Turpitude. International Review of Economics.
55:4. pp. 315-350.
Tower, Edward. 2009a. “Performance of Actively Managed Versus Index Funds: the Vanguard
Case” Chapter 12 of Mutual Funds: Portfolio Structures, Analysis, Management, and
Stewardship, edited by John A. Haslem. Hoboken: Wiley 2009. Pp. 211-236.
Tower, Edward. 2010a. “Strategic Asset Allocation in Practice: Using Vanguard Funds to Clone
GMO’s Benchmark-Free Allocation Fund.” Duke University Working Paper, October (I
hope).
Tower, Edward. 2010b. GMO’s Predictions as Pilots for Vanguard Portfolios: Are They a Useful
Guide for Strategic Asset Allocation? Duke University “Working Paper, October (I hope).
5
Exhibit 1. GMO Funds Returned Less than their Vanguard Counterparts Over Last 1, 3, and 5 Years, Returned More over 10
Years, and Much More from 1 July 2000 Through 30 June 2005. Thus Recently Vanguard has Outreturned GMO and
Comparisons of Returns Only Over the Entire 10 Year Period Paint an Incomplete Picture.
Fund family
GMO
Vanguard minus GMO
20002000# of years
1
3
5
10 2005
1
3
5
10 2005
GMO Fund
Vanguard Fund
Return (nominal, geometric average, %/year
6.1 7.24 -2.9
1.2 1.0
0.1
-0.9
GMDBX Dmestic Bond III
VBMFX Total Bond Idx Fund 11.2 6.2 4.9
15.2 20.55
1.6
3.2 2.0 -2.0
-6.2
GMCEX Emerging Countries III
VEIEX Emerging Markets Idx 13.7 -4.8 10.0
16.0 21.86
1.1
3.1 1.6 -2.8
-7.5
GMOEX Emerging Markets III
VEIEX Emerging Markets Idx 14.2 -4.8 10.4
3.2 7.19
3.4 -7.9 2.9 -0.7
-4.4
GMOFX Foreign III
VDMIX Developed Mkts Idx -2.6 -1.1 -0.6
10.5 -5.2 6.6
12.3 18.29 -0.9 -1.2 -2.2 -6.4 -10.9
GMFSX Foreign Small Cos III
VINEX Intl Explorer
xxx
GMIPX Infln Indexd Plus Bond VI VIPSX Infln Protected Secs 20.7 4.1 xxx
xxx xxx -10.6 2.8 xxx xxx
xxx
0.3
1.0 0.8
xxx
xxx
GMIEX Intl Core Equity III
VDMIX Developed Mkts Idx 0.5 -10.1 1.5
xxx
6.3 -6.9 3.0
xxx
1.9
1.2 2.0
xxx
xxx
GMIGX Intl Growth Equity III
VWIGX Intl Growth
xxx
0.4 -8.2 3.6
11.0 18.86
9.2
1.9 0.8 -5.1 -11.5
GMISX Internatl Small Cos III
VINEX Intl Explorer
-1.7 -10.7 1.1
6.8 12.84
1.7
2.7 2.5 -1.3
-5.3
GMOIX Intl Intrinsic Value III
VTRIX Intl Value
6.9 -3.4 1.8
xxx
2.4
0.5 2.4
xxx
xxx
GQETX Quality III
VDIGX Dividend Growth
xxx
23.0 -4.0 3.0
9.9 17.26
1.6 -0.6 0.0
0.5
1.0
GMORX Real Estate III
VGSIX Real Estate Idx Fnd
-0.1
1.1 -1.4
0.2 1.80
8.0 -8.4 2.1 -0.8
-3.8
GMUEX Core Equity III
VFINX 500 index Fund
9.9 -4.4 0.0
-4.2 -8.23
0.3
0.0 2.2
4.6
6.8
GMGWX U.S. Growth III
VIGRX Growth Index
7.0
-9.3
-1.9
2.4
-0.9
-0.3
1.8
-1.1
-4.1
GMVUX U.S. Intrinsic Value
VIVAX Value Index
6.97
-0.4 0.72 -1.6
4.2 5.9 -1.5
-8.5
GMSPX Small/Midcap growth III VMGRX Midcap Growth Idx* 14.6 -8.5 -1.5
GMSUX U.S. Small/Midcap Val III
GUSTX U.S. Treasury
VMVIX/VISVXMidcap/Smallcap Value Index.**
VFISX Short-Term Treasury
13.0
0.1
-6.3 -1.8
xxx
xxx xxx
Average Vanguard superiority (Average differential return: Vanguard-GMO)
Median Vanguard superiority (Median differential return: Vanguard-GMO)
5.9 14.21
-1.7
1.7
3.3
1.4
-0.8
xxx
3.1
xxx
xxx
xxx
xxx
0.88 0.29 1.81 -1.17 -4.32
1.31 1.17 2.00 -1.07 -4.42
*VMGRX SELECTED AS BENCHMARK RATHER THAN VISGX BECAUSE ITS RETN MORE CLOSELY TRACKED GMSPX.
**VMVIX (inception 2006) is benchmark for 1 and 3 years, VISVX is benchmark for 5 and 10 years.
Data is returns over the most recent 1, 3, 5, and 10 years from Morningstar on line, through Wednesday, September 23, 2010.
6
Exhibit 2. Average excess returns of Vanguard funds
over their GMO counterparts
year
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
from start of year indicated to end
of 2009, %/year
5.85
1.03
1.01
1.66
1.22
0.91
0.20
-0.07
-1.67
-1.43
0.03
0.23
0.37
0.05
0.39
0.85
0.17
during
single
year, %
5.85
0.46
1.96
2.17
-1.19
-0.32
-3.33
-8.01
-7.29
1.32
12.15
10.07
1.24
5.08
9.45
-1.80
-12.39
7
Exhibit 3. Average excess return of Vanguard funds
minus corresponding GMO funds(%/year, geometric
average through December 31,2009)
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00
-1.00
-2.00
-3.00
1993
1997
2001
Start date
8
2005
2009