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a touch worse than the market’s 43.2% decline, the sector has tended to hold up better over longer periods, so I’ll give it a pass. That brings us down from 12 to just three sector indexes worth considering as long-term investments: Consumer staples, energy and health care. That doesn’t mean I’d buy them, but from a risk and return perspective, they do survive a couple of cuts. Painting a Chart For those who are more visually oriented, you know that I am also a fan of relative-return charts. These charts require little explanation, and quickly round out the story told by the rolling return table. The charts on the next page compare the performance of each of the 12 sector indexes, as well as Vanguard’s three active funds, against the Wilshire 5000 index. When the line is rising, the sector fund or index is outperforming the Wilshire 5000 index. When the line is falling, it is trailing the market. There are several things I want to draw your attention to. First, as I’ve said throughout, each sector goes through periods of outper- formance (rising lines) and underper- formance (falling lines). Good luck trying to make a trade before a rising line begins to fall, or vice versa . Second, I have held the scale con- stant across the charts to highlight that for many of the sectors, performance tends to be fairly similar to the market over time, while for others it is all over the map. For instance, the line comparing the MSCI Industrials >

gy, health care, industrials and REITs. (Note that all three of the actively man- aged funds also make the cut—more to come on that.) So there’s been a 50-50 chance of picking a sector that gener- ated market-beating returns over mul- tiple rolling time periods. I’m looking for better odds than that. Additionally, don’t forget that returns are only half the equation. Risk should factor into the thinking as well. Every sector has its time to shine, but as I’ve discussed, if you are going to invest in a sector for the long haul, you have to be prepared to stick with it when the clouds roll in. And some sectors have experienced storms that would test any- one’s conviction. So, from the first cut of six, let’s talk about REITs for a moment. The MSCI REIT index’s worst 12-month loss was a terrifying 59.1% decline. And over five- year periods, the worst for the index was one-and-a-half times that of the overall stock market, a 9.0% decline versus the market’s 6.0% annualized loss. Or consider the MSCI Consumer Discretionary index’s worst one-year decline of 44.6%. Not as dreadful, but its worst five-year return of -10.6% annual- ized would test even the most resolved investor’s patience. Flipping that around, the MSCI Industrials index’s worst long- term returns haven’t been much worse than the broad market’s, but its worst one-year loss of 52.7% probably would have sent even the firmest believers run- ning for the hills. While the MSCI Energy index’s worst 12-month loss of 43.4% is just

funds faltered for different reasons, and their minimal assets were absorbed by other Vanguard funds many years ago. Since then, sector investing has been an indexing affair at Vanguard, start- ing with REIT Index, introduced in 1996, and then continuing with 10 MSCI-index based sector funds opened in 2004. Most recently, Global ex- U.S. Real Estate Index , based on an S&P benchmark, was introduced in November 2010. Even as Vanguard’s sector options have become more index-based, Bogle has become more and more critical of the trend, particu- larly as they proliferate through the use of exchange-traded funds. But what do the performance num- bers have to say? Earlier, I showed you calendar-year returns to make a specific point, but you know I prefer rolling returns over point-in-time returns when it comes to looking at performance. As most of Vanguard’s sector index funds have but a decade of real-world returns under their belts, I used the historical index data dating back through 1994 to provide us with about two decades’ worth of perspective. The table below looks at that data for all 12 of the sector indexes (11 from MSCI and one from S&P), the Wilshire 5000 index, plus the three active sector funds in Vanguard’s stable. Let’s try to winnow down the win- ners from the losers. Six out of 12 sec- tor indexes showed better rolling one- year, three-year and five-year returns, on average, than the market: Consumer discretionary, consumer staples, ener-

Rolling Through the Sectors

One-year

Wilshire 5000

MSCI

Consumer Disc.

MSCI

Consumer Staples

Energy

MSCI

Energy

MSCI

Financials

Health

Care

MSCI

Health

Care

MSCI

Industrials

MSCI

Info. Tech.

Precious

Metals & Mining

MSCI

Materials

MSCI REIT

MSCI

Telecom

MSCI

Utilities

S&P Global ex-U.S.

Property

Best 56.5% 82.2% 44.4% 66.8% 55.2% 85.1% 60.5% 54.9% 72.5% 113.3% 105.4% 73.3% 110.5% 72.7% 56.8% 80.2% Average 10.7% 12.4% 11.3% 15.8% 14.6% 11.1% 16.3% 12.7% 11.9% 13.7% 11.0% 10.1% 13.7% 8.6% 9.9% 10.4% Worst -43.2% -44.6% -24.1% -47.8% -43.4% -64.0% -27.8% -30.2% -52.7% -66.1% -66.0% -54.0% -59.1% -57.2% -34.0% -59.8% Three-year Best 31.1% 39.0% 33.4% 45.7% 38.5% 44.1% 34.2% 37.1% 32.4% 66.2% 53.6% 31.4% 43.5% 42.2% 26.1% 41.3% Average 7.9% 9.4% 9.0% 13.5% 12.1% 6.6% 13.7% 9.6% 8.3% 8.6% 9.9% 7.4% 11.1% 5.7% 8.2% 7.1% Worst -16.3% -19.6% -2.5% -8.0% -9.2% -32.5% -7.5% -9.2% -18.2% -38.9% -24.8% -13.1% -25.7% -36.2% -13.3% -20.3% Five-year Best 25.8% 33.8% 19.4% 35.3% 30.9% 25.8% 31.1% 27.6% 28.2% 50.6% 40.9% 24.8% 29.6% 31.2% 22.1% 32.6% Average 5.8% 6.8% 7.5% 13.7% 11.5% 4.4% 12.3% 7.5% 6.7% 5.3% 12.0% 6.8% 10.2% 1.9% 6.8% 7.3% Worst -6.0% -10.6% -2.3% -3.9% -1.0% -18.3% -0.4% -3.5% -6.7% -20.1% -17.1% -5.0% -9.0% -18.2% -4.5% -7.6% Source data: MSCI, S&P, Wilshire Assoc. Analysis: FFSA

The Independent Adviser for Vanguard Investors • June 2014 • 13

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