(PUB) Vanguard Advisor

wide margins. Investors and traders responded by pouring record amounts of money into the two health care funds in February: $193 million cascaded into Health Care, making it the single largest month for inflows in a decade, while $366 million flooded into Health Care Index, an amount that was more than twice that of its best month prior to that. Since the end of February, Health Care is down 0.3% and Health Care Index is off 0.6%, while Total Stock Market has gained 2.8%. That’s not a complete disaster, but it’s probably not what investors were expecting when they traded into the funds with their eyes on the 40%-plus returns in the rear-view mirror. Of course, a disciplined approach to sector investing doesn’t have to involve trading between sectors—you could partner with a sector for the long term. In fact, you and I have done very well focus- ing on one excellent sector: Health care. We have also benefited from the standout team at Wellington Management that runs Health Care, or the equally excep- tional Hartford Healthcare (HGHAX), which I recommend as an alternative if you can buy it without a load. Still, the unfortunate truth is that most people shouldn’t even consider investing in sector funds to begin with. Vanguard’s Sectors If sector investing increases the risk of poor investor behavior, not to men- tion that it seems anathema to the Vanguard tradition of buy-and-hold and broad index diversification, why does Vanguard offer investors sector-specific funds in the first place? The simple answer: It’s another way to grow assets. And with roughly $115 billion in assets under management, Vanguard’s sector- specific funds and ETFs have been a good business for Vanguard. Still, Vanguard has always been somewhat bipolar when it comes to sector investing. Alongside the energy, health care and precious metals funds, which opened 30 years ago in May 1984, Vanguard founder Jack Bogle also introduced funds investing in what he called the “service economy” and tech- nology. Both of those actively managed

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Market Rotation

each index tracked by Vanguard’s sec- tor funds and ETFs along with the returns from the Wilshire 5000 index (a measure of the overall stock market) for the last 10 calendar years, in descend- ing order. The only pattern I see is that the Wilshire 5000 index never comes out at the very top or falls to the very bottom, which is what we would expect from a diversified portfolio. If you can discern another pattern, then you may have a career awaiting you in the cipher division of the military. Second, but not unrelated, if you are going to try your hand at being an active sector investor, you’d better have a very well-defined and well-conceived strategy guiding you—one which you are prepared to stick to through thick and thin, because invariably there’ll be plenty of times your method doesn’t work. I don’t say that to knock any par- ticular strategy, but out of acceptance of the fact that no strategy works all the time. And if you aren’t following a disciplined strategy, you really are just speculating—and likely to get burnt. The first five months of 2014 have illustrated just how difficult it can be to correctly and profitably weave in and out of various market sectors. Though the overall U.S. stock market is pretty much where it started the year— Total Stock Market is only up 4.3%—there

Consumer Disc. Index Health Care Health Care Index Total Stock Market Financials Index Info. Technology Index Consumer Staples Index Energy Index Materials Index Telecom Svcs. Index Energy Utilities Index Global ex-U.S. R.E. Index REIT Index

2013 Return 2014 YTD Return

-40% -30% -20% -10% 0% 10% 20% 30% 40% 50% Prec. Metals & Mining

has been an active rotation of buying and selling under the surface. The chart above shows Vanguard’s sector fund returns for 2013 as well as the first five months of 2014. A number of last year’s laggards, like REIT Index , Utilities Index and Energy Index , are lead- ing the way, while some of last year’s leaders, like Consumer Discretionary Index , are trailing. Despite the warnings that past per- formance isn’t indicative of future returns, the lure of past returns is all too often tempting for many inves- tors, drawing them in at just the wrong time. Let’s look at just one recent example: Over the 12 months end- ing February 2014, Health Care and Health Care Index returned 47.4% and 41.5%, respectively, outpacing Total Stock Market’s 26.7% return by

Crazy Quilt of Returns

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

39.9% 33.2% 31.5% 23.3%

35.3%

45.6%

34.4% (16.4%) 26.5% (23.4%) 17.5% (28.0%)

62.2%

30.9% 19.1% 40.9% 43.7%

17.4% 37.3%

51.8% 28.5% 14.0% 26.4% 42.8%

15.0% 13.0%

35.9% 21.7%

47.5% 46.8% 29.4% 28.6% 22.5% 22.2%

27.4% 10.7%

24.9%

42.1% 34.0% 33.1%

15.1%

(33.2%)

24.6% 8.7% 19.2%

19.3% 8.5% 21.0% 13.9% (36.9%)

21.0%

4.5% 18.7%

18.8% 6.3%

19.8% 13.4%

(37.3%) (38.0%) (38.0%) (39.9%) (42.8%) (46.7%) (49.1%) (53.0%)

17.9% 3.8%

17.8% 31.1%

16.9% 6.3% 19.5%

10.5%

17.7% 17.2%

3.5% 17.5% 27.4% 0.7% 17.2% 25.7%

14.1%

4.9%

16.8%

8.0%

13.9% 4.5%

15.9% 5.7%

19.4% 14.9%

0.6% 16.1%

25.0% 15.1% 14.7%

12.6%

3.9% 15.0%

1.9%

15.6% 14.5% (2.0%) 14.4% 12.8% (9.3%)

14.2% 10.9%

9.3% 3.1% 14.7%

(11.4%)

4.4% 1.7%

(2.1%) (4.1%)

9.2% (16.8%) 6.8% (17.3%)

12.6% 7.2%

(14.2%) (16.0%)

3.6% 2.1%

4.4% 2.5%

11.7%

6.0%

n Wilshire 5000 n MSCI Consumer Discretionary n MSCI Consumer Staples n MSCI Energy

n MSCI Financials n MSCI Health Care MSCI Industrials

n MSCI Info. Tech n MSCI Materials n MSCI REIT

n MSCI Telecom n MSCI Utilities n S&P Global ex-U.S. Property

12 • Fund Family Shareholder Association

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