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Analysis of the largest active domestic equity mutual funds in defined contribution plans shows slight outperformance in the long term but some significant dispersions

In John C. “Jack” Bogle's new book, “The Clash of Cultures,” he presented an analysis of Pensions & Investments' data on mutual funds most used in defined contribution plans. The results were very interesting and inspired P&I to do more analysis (highly unscientific as it was).

The objective of the P&I analysis was to understand whether the largest active domestic mutual funds in defined contribution plans outperformed a passive total U.S. stock market mutual fund. P&I created an equal-weighted basket of the 10 largest active mutual funds and compared it to the Vanguard Total Stock Market Index Fund Investor Shares (VTSMX). The basket of active mutual funds was rebalanced at the end of each year to be reallocated equally among the 10 largest active domestic mutual funds.

Somewhat surprisingly, the basket of active mutual funds outperformed, after fees, the passive option for the 10 years ended Dec. 31, 2010 (the latest available data). The active basket had an annual return of 3.001% while the Vanguard Total Stock Market Index Fund returned 2.448%. Excessive risk was not taken to get earn the extra 0.553 percentage point. The standard deviation of annual returns of the active basket was 21.81% while the passive option was only slightly lower, at 21.78%.

However, even though the active basket outperformed, it is doubtful an individual retirement plan participant would have fared as well. As Mr. Bogle points out, there is a high dispersion of returns of among actively managed funds year by year. The average difference between the best- and worst-performing fund was a breathtaking 17.61 percentage points.

The extreme nature of winners and losers year-to-year highlights that defined contribution plan participants are probably better served by a passive total stock market index, as Mr. Bogle echoes throughout his latest book.

Data Editor Timothy Pollard contributed to this post.