(PUB) Vanguard Advisor

Vanguard complex according to the lat- est data I’ve seen, it’s almost certain to give index fund investors agita. Another company, Medtronic, is the 57th largest holding, and Abbott Labs is the 60th. (Yes, those invested only in IRAs or

horrid, but our Vanguard money funds are safe and well-run. On another note, the “inversion” trend, which has been picking up momentum this year, is now finally on policymakers’ radar in Washington. In sum, U.S. companies are increasingly seeking out foreign firms for mergers with the explicit objective of using the acquisitions to reincorporate in foreign countries where corporate taxes are lower. Say what you will about tax- avoidance schemes and the fact that these companies are benefiting from all the services U.S. taxes pay for without contributing their fair share, but what’s gotten short shrift in the media is the tax impact on you and me. That’s right, us, the small investors. When a company completes an inver- sion, U.S. investors must recognize all of the taxable gains in that company’s stock. It’s as if you sold the stock, or for fund shareholders, it’s as if your mutual fund sold the stock—which means that there could be a heavy tax to pay come 2015 if more and more inversion trans- actions take place before year-end. Mutual fund companies in general have been quiet on this issue. In May, when it still appeared that Pfizer would complete an inversion transaction with AstraZeneca, I asked Vanguard what the capital gains exposure would be for shareholders given that, at the time, Pfizer was the ninth largest holding across all of Vanguard. They never came up with an answer, but I can virtually guarantee you it would have been a whopper. Pharmaceutical companies have been particularly active in this arena. Pfizer could still be in the hunt, and as the 13th largest of the approximate- ly 4,000 different holdings across the

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market, it doesn’t always work out that way. Consider, for instance, Health Care ’s 28.9% return over the past 12 months. Does this mean we have been in the grips of an early bear market for a year? I don’t think so. In fact, there’s a very good chance we are still very much mid-cycle in the economic recovery as well as the stock market’s rotation. And about that rota- tion, Jeff’s analysis shows that there really isn’t much of a pattern you can hang your hat on. I would hate to build a portfolio of certain market sectors, and then hope to trade through them while guesstimating our position in the eco- nomic and market cycle. From what we see in the data, there’s no “there” there. And if you flip it around and try to figure out where we are in the cycle by what’s doing well now and what’s faded in recent months, well, good luck with that. As I said, I think this long, slow grind means we are well into the middle of the economic and market expansion. Do I know how long this mid-cycle phase will last? No. Does it make me want to change our portfolios or adjust our investments? Absolutely not. On to other things: The SEC finally made a decision about money funds, and the good news for you and me is that we can continue to rely on our funds being priced at $1.00 per share day in and day out: No variable pricing for us individu- als. The SEC also gave money funds the ability to suspend redemptions for up to 10 days if panic selling gets in the way of orderly management of a fund. For institutions, it’s more complicated, but for Vanguard investors like us, I think this is a non-event. The yields may be

We are still very much “mid-cycle” in the economic recovery as well as the stock market’s rotation.

other tax-deferred accounts can ignore this.) I’ve wondered about Health Care, with a net 45.2% of its portfolio show- ing unrealized capital gains. Obviously, its portfolio is loaded with pharma stocks. The PRIMECAP team also has a lot of health care exposure. While the impact of inversions on mutual fund investors has not yet made waves, the swells may come during December’s distribution season. And no, I won’t be selling Health Care or any of the PRIMECAP-managed funds to avoid a potentially large distribution. Remember, selling a fund creates its own tax liability. But I certainly will be keeping my eyes and ears open. Finally, Vanguard removed the front- and back-end loads on World ex-U.S. SmallCap Index , a fund I believe is a worthy competitor to International Explorer in the overseas arena. Since the index fund’s inception a bit more than five years ago, it’s up 135.1% versus International Explorer’s 141.5% gain. I have a Hold on both as I expect the team at International Growth to give us at least some exposure to faster- growing companies overseas. n

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