(PUB) Vanguard Advisor

VANGUARD.COM Ghost in the Machine

IT’S BEEN A BIT MORE than a decade since Vanguard shut the doors on Capital Opportunity for what would turn out to be a nine-year closure before reopening it briefly, then closing the doors once again. And, while I have nothing but praise for the PRIMECAP Management team and their stewardship of our money, I think it’s important to recognize that, as I’ve said for years now, the Capital Opportunity of today is a far cry from the fund it was in its early years. In fact, despite some differences in portfolios, the performance of Capital Opportunity and PRIMECAP has been almost iden- tical. Identically good, I should add. From the end of March 2004, when Vanguard closed the then-$7.4 billion fund, through August 2014 Capital Opportunity (now with $12.5 billion in assets) has gained 185.6% versus a 180.6% gain for PRIMECAP, with its $42.9 billion in assets. SEND IN THE POLICE. When is 1.2% the mid-point between 0.0% and 3.0%? For that matter, when is 6.0% the mid-point between 0.0% and 20.0%? How about never? The mid-points are 1.5% and 10.0%, unless you’re Vanguard.com’s interactive “Principles for Investing Success” cost calculator, that is. My sharp-eyed Senior Managing Editor, Billy Currano, found this bug in Vanguard’s system this past month, and Jeff DeMaso and I both confirmed that Vanguard’s programmers need to do a bit of tweaking if you’re to believe the numbers the calculator shows. In a nutshell, as you read through Vanguard’s principles online, you’re given a calculator that shows that an investor with $10,000 who pays 1.2% in expenses and earns a 6.0%

Low Costs Are Good, But Not This Good WHAT VANGUARD SAYS

THE REAL NUMBERS

Kept

Lost

Kept

Lost

1 year 5 years 10 years 25 years 50 years

$837.44 $4,949.73 $12,349.43 $64,673.43 $547,612.04

$162.56 $1,155.37 $3,588.00 $33,673.63 $616,296.49

$474.31 $2,607.44 $5,894.74 $21,851.79 $91,453.64

$125.69 $774.82 $2,013.73 $11,066.92 $82,747.90

Note: Assumes 6.0% annualized return and 1.2% expense ratio.

numbers are a bit more, um, tame. You’ll have $91,454. I’m guessing Vanguard’s going to put the fix in shortly, so hopefully, this partic- ular error won’t pop up again. However, the lesson learned is permanent: You can trust, but you also have to verify. Even if you paid nothing in expenses and earned a 6.0% percent return, you’d only have $184,201 at the end of 50 years, which is a far cry from half a million. n

return over 10 years will end up with $12,349.43 while “losing” $3,588.00 to expenses. The problem is, those num- bers are wrong. Actually, the investor would keep just $5,894.74 and lose $2,013.73 to expenses. (At least that’s what Vanguard’s calculator says once you jigger with the dials to recalibrate it.) And no, you won’t end up with $547,612 after 50 years of investing at 6% with a 1.2% expense ratio. The

PRIMECAP When One Fund Acts Like Another

In the meantime, PRIMECAP Management’s private-label Odyssey Aggressive Growth has continued on the path of smaller-cap outperformance. Since inception in November 2004 (just eight months after Capital Opportunity’s closure), the private-label fund is up 266.5% versus Capital Opportunity’s 177.3% gain over the same period. Now, don’t get me wrong: No mat- ter which PRIMECAP-run fund you bought, you far outpaced the stock mar- ket. (Don’t tell all those folks who believe you can’t find great active managers, please. Let’s keep this to ourselves.) In fact, Capital Opportunity also per- formed light years ahead of the small- cap and mid-cap indexes, as well as S&P MidCap 400 Growth ETF since I added it to our Growth Model Portfolio at the end of April 2012 in my desire to add back greater mid-cap exposure. As it turns out, no matter which portion of the market you indexed, you just

The PRIMECAP Record

3/31/04– 8/31/14

10/31/04– 8/31/14

PRIMECAP

180.6% 168.3% 185.6% 177.3% 129.7% 127.2%

Capital Opportunity Total Stock Market Odyssey Agg. Growth

— 266.5%

couldn’t keep up with the great stock- picking at Capital Opportunity (or the other PRIMECAP-managed funds, for that matter). If you take a look at the chart on page 15, you’ll see not only that the relative performance between Capital Opportunity andPRIMECAP flattens out considerably after the 2004 closure (and even more so after assets hit a peak in 2007), but also that Odyssey Aggressive Growth has consistently outperformed since its inception. (Note that the lon- ger line rises when Capital Opportunity is outperforming PRIMECAP and the

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