By Colin Barr
September 30, 2010

So much for this being a stockpicker’s market.

Vanguard, the leading purveyor of mutual funds that track market indexes, has passed Fidelity Investments as the largest U.S. mutual fund company by assets — dethroning Boston-based Fidelity after two decades as the top fund manager.

Vanguard had $1.31 trillion in assets at July 31, Bloomberg reports, compared with $1.24 trillion at Fidelity.

The shift comes at a time when investors are shunning the actively managed funds typified by Magellan, the Fidelity fund once run by legendary stockpicker Peter Lynch. Lynch famously told investors to “invest in what you know,” buying shares of companies whose products they used.

They rewarded him by pouring billions of dollars into his fund. His strong performance — Magellan averaged a 29% annual return over his tenure — and his visibility sent the fund’s assets under management soaring to $13 billion in 1990 from $20 million in 1977.

Magellan and other actively managed funds continued to grow during the stock boom of the 1990s, with Magellan’s assets ballooning at the market’s peak a decade ago to more than $100 billlion.

But the last 10 years haven’t been happy ones for stock investors, and many have come to question the wisdom of investing in the stock market altogether — let alone the value they get in return for the higher fees they pay for active stock fund management.

Investors have withdrawn money from stock mutual funds every week since May’s flash crash, according to the Investment Company Institute. Bloomberg notes the torrent of dollars rushing out of funds run on the Lynch model and into passively managed ones.

Investors took a net $301 billion out of actively run equity funds in the U.S. from the start of 2008 through August, Morningstar estimates, while stock-index funds attracted $113 billion.

Thus the rise of Vanguard, whose expense ratios tend to be just a fraction of those charged by actively managed funds such as Magellan, not to mention the many exchange-traded funds that also track indexes and offer low fees.

None of this is to ignore the fact that buying index funds or ETFs is far from an ironclad strategy alone. Looking across the universe of funds, actively managed funds have actually done better than the indexers, Bloomberg notes.

In the 10 years ended Aug. 31, actively run domestic stock funds returned 0.9% a year compared with an annual loss of 2% for index funds.

But the travails of a few high-profile active managers, such as the various managers of Magellan and the post-bubble meltdown of Legg Mason’s Bill Miller, tend to obscure that fact.

An investor who socked $10,000 into the Vanguard Index 500 fund a decade ago could hardly be expected to be exulting over the 8 grand and change that’d be left now.

But that’s a darn sight better than what they’d have with Magellan, whose average annual return over the past decade is -3.78% — a decline twice as deep as the S&P 500’s. Invest in what you know indeed.

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