(PUB) Investing 2015

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6 • Fund Family Shareholder Association
other ETF providers don’t. But if
reported annualized returns are off by
25 basis points over 10 years, you can
readily figure that is going to add up
over time. And if this is what’s going
on at Vanguard, I would be really, really
skeptical about others in the industry.
How accurate are their numbers? Are
investors actually flying blind?
Plus, are ETFs really better than
open-end funds? I went back and
matched up Vanguard’s ETFs with its
open-end siblings. Now, obviously the
Investor shares of Vanguard’s open-end
funds have higher expense ratios than
the ETFs. And yet, 36% of Vanguard’s
Investor share index funds outper-
formed their like ETF shares. The ratio
swings much further to the benefit of
the open-end fund when you look at a
comparison with Admiral shares, where
the operating expenses are identical in
most if not all cases. Fully 74%, or 23
of the 31 Admiral share mutual funds,
outperformed their ETF clones. That
outperformance ranged from as much
as 64 basis points (0.64%) to as little as
1 basis point (0.01%). When the fund
shares lagged the ETF shares, it was by
between 3 and 13 basis points.
In other words, not only were the
odds in favor of an Admiral share
outperforming an ETF share by about
two-to-one, but when the ETFs did
win, it wasn’t by much, whereas the
Admiral shares could, at times, gener-
ate returns a good half of one percent
better over a short, 12-month period.
As you know, I’m not a fan of ETFs
per se, as I believe Vanguard’s best
active managers will run circles around
their index benchmarks. That said,
because many FFSA members asked
for an index-only model portfolio, I
built the Growth Index Model Portfolio
to attempt to mimic the Growth Model
Portfolio and accommodate those
requests. But if performance is really
what ETFs are all about, then someone
needs to remind investors they might
be better off sticking with the tried and
true, rather than the new. n
WHEN STOCKS HIT NEW HIGHS, only
one of two events can follow: Stocks
can either go on to make a new high,
or they can decline to some lower level.
Given the number of highs hit last year,
these two prospects have many inves-
tors unsure of how to proceed today.
But is there a better way to think about
potential outcomes when investing at
what might be a high-water mark?
Depending on how heavily you’ve
invested in the stock market, you may
view new highs with excitement. But
for many, a new high is met with trepi-
dation. For those investors, there’s a
sense that the market is overvalued and,
like a hot-air balloon, will inevitably
come back down to earth—sometimes
faster than they’d like. I hear this most
often from those who are either not cur-
rently invested or aren’t invested heav-
ily enough in stocks and are worried
they’ll be getting in at the top, as well
as investors who have been in the mar-
ket for a while and worry that it may be
time to lock in some gains.
To put some numbers on it, take
a look at 500 Index, which gained
13.5% in 2014, hitting 57 new highs
along the way. At the end of January,
the index fund was only 4.5% below
its December 29 high (on a total return
basis). Yet, investors seem scared.
Investors are struggling with two con-
cerns here. One has to do with the ques-
tion of whether stock market values have
gotten too high and are poised to revert to
the mean—that the pendulum will swing
the other way. The other deals with how
one should approach investing when
markets are at or near all-time highs. Let
me try to unpack these.
You’ve heard me say it before, but it
all comes down to earnings and interest
rates. We can all flap our gums about
jobs and housing starts and consumer
confidence and the like. But when it all
gets to be too much, simplify.
Interest rates are low, and they’ll
stay that way for a long time. Even
when the Fed starts lifting short-term
rates, there’s no reason to believe that
long-term rates will go sky-high unless
we get some serious inflation. So far
that’s not in the cards. That’s a posi-
tive for U.S. stocks, which compete for
investors’ dollars with bonds.
I think the bigger issue is whether
profits keep growing, and at what rate.
Profit margins have been healthy, but
much of that has been a bit of earnings
engineering and cost-cutting. What we
need to see is more top-line, or revenue,
growth. If that can be revved up, then
the bottom line should follow.
While earnings are a basic metric
by which stock values are often mea-
sured, it’s a tricky business, as there
are seemingly endless ways to “value”
a stock, or a market of stocks. There
are multiple ways to measure earnings,
and some investors prefer to look at
corporate sales or cash flows or book
values or even GDP—the list goes on.
Vanguard’s research team has looked at
myriad valuation metrics and conclud-
ed that not a single one has even a 50%
chance of predicting where the stock
market will be in the not-too-distant
future. And still, without getting hung
up on any one valuation ratio, it’s fair to
NEW HIGHS
Investing at a (Potential) Top
Errors in ETF Return Reports
1-yr. 3-yr. 5-yr. 10-yr.
Largest outperformance reported by Vanguard 0.26% 0.33% 0.16% 0.32%
Largest underperformance reported by Vanguard -0.47% -0.68% -0.39% -0.21%
Note: Differences in annualized returns for periods ending 12/31/2014.
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