(PUB) Investing 2015

608 / 772

14 • Fund Family Shareholder Association
many adherents—even at Vanguard.
Consider that Vanguard has often
handed assets over to quantitative man-
agers who, in part, rely on past per-
formance to choose stocks for their
portfolios. To name a few, just look
at the momentum strategies employed
by Acadian Asset Management
(Global Equity) or Vanguard’s Equity
Investment Group (Strategic Equity,
Strategic SmallCap Equity , U.S.
Value and various other sub-portfolios)
or the managers at Growth & Income.
As I’ve said, the Hot Hands approach
doesn’t work each and every year, and
some “persistence of performance”
investors have had their heads handed
to them over the years chasing the
strategy. One fund guru who used to
pursue the “persistence” theory gave
it up because it didn’t work within the
huge sea of funds that he was track-
ing, then came back to it when results
turned around. But after 2007, 2008
and 2009, he began to question whether
the theory still held true. It failed to beat
the market in 2010, and as far as I can
tell, the strategy has been abandoned
completely.
However, I should note that this per-
sistence tracker set himself up against
a rather easy benchmark: The average
equity fund. I consider the average fund
a low hurdle that doesn’t hold a candle
to the market benchmark I use.
My Hot Hands is better, and 2014
notwithstanding, it works.
Why It Works
One of the reasons why Hot Hands
works over the long run at Vanguard
and not within the greater universe of
funds is that Vanguard’s fund objectives
and investment policies are very well-
defined. With Vanguard’s funds, there’s
little room for managers to change their
tactics. (Though as we’ve seen time and
time again, there is room for managers
to change.) The managers do what they
do, and they keep doing it, no matter
how the markets move around them.
If they don’t, then generally Vanguard
fires them. One thing Vanguard wants
is managers who strictly follow their
investment styles and objectives.
So using the prior year’s perfor-
mance as a guide for selectingVanguard
stock funds is not only useful, but very
profitable, because investment styles
and markets don’t automatically shift
once the calendar turns from December
to January. And ignoring hot strate-
gies, or going with the “dogs,” as some
investment advisers who use a “contrar-
ian” approach like to suggest, can lead
Vanguard investors to market-lagging
and even negative returns. Dogs are
dogs for a reason. They make great
pets, but lousy bets. (Again, unless
there’s a manager change for the bet-
ter, or, as has been the case for a few
years, a great fund and manager like
Don Kilbride and Dividend Growth are
simply are out of favor for a cycle.)
But, let’s get back to the Hot Hands
winners. Here are the ground rules for
the strategy as I originally set them out in
1995, when I conducted the first analy-
sis (and when we owned PRIMECAP,
1994’s best fund, inour Model Portfolios).
I’ve continued to follow these rules and
have updated my research as new funds
have been introduced.
I have looked at the best and worst
Vanguard equity funds for each year
between 1981 and 2014. The funds
I exclude are sector funds, such as
Energy, Precious Metals & Mining,
Health Care, both of the REIT funds
and the old Utilities Income (now
Dividend Growth, which I do include),
as well as the regional international
index funds, Emerging Markets Stock
Index, European Index and Pacific
Index, since they are what I would con-
sider sector funds. I’ve also excluded the
actively managed Emerging Markets
Select Stock . Plus, I don’t consider bal-
anced funds and Market Neutral, which
besides having a prohibitive investment
minimum is really a hybrid fund.
However, I do include the diversi-
fied internationals in the mix. You see,
domestic funds have the right to invest
overseas, and, indeed, funds like U.S.
Growth or PRIMECAP can and have
Long-Term Performance
Hot Hands fund Total return Following year Total Stock Market*
1981 Windsor 16.8% 21.7% 18.7%
1982 SmallCap Index 46.4% 18.2% 23.5%
1983 International Growth 43.0% -3.3% 3.0%
1984 Windsor 19.4% 28.0% 32.6%
1985 International Growth 57.0% 56.7% 16.1%
1986 International Growth 56.7% 12.5% 2.3%
1987 International Value 24.0% 18.8% 17.9%
1988 Windsor 28.7% 15.0% 29.2%
1989 U.S. Growth 37.7% 4.6% -6.2%
1990 U.S. Growth 4.6% 46.8% 34.2%
1991 Explorer 55.9% 13.0% 9.0%
1992 Convertible Securities 19.0% 13.5% 10.6%
1993 International Growth 44.7% 0.8% -0.2%
1994 PRIMECAP 11.4% 35.5% 35.8%
1995 Windsor II 38.8% 24.2% 21.0%
1996 Windsor 26.4% 22.0% 31.0%
1997 PRIMECAP 36.8% 25.4% 23.3%
1998 Growth Index 42.2% 28.8% 23.8%
1999 Capital Opportunity 97.8% 18.0% -10.6%
2000 SmallCap Value Index 21.9% 13.7% -11.0%
2001 Selected Value 15.0% -9.8% -21.0%
2002 Global Equity -5.6% 44.5% 31.4%
2003 International Explorer 57.4% 31.8% 12.5%
2004 International Explorer 31.8% 20.5% 6.0%
2005 International Explorer 20.5% 30.3% 15.5%
2006 International Explorer 30.3% 5.2% 5.5%
2007 Growth Equity 22.5% -47.9% -37.0%
2008 Dividend Growth -25.6% 21.7% 28.7%
2009 Capital Value 81.5% 20.2% 17.1%
2010 SmallCap Growth Index 30.7% -1.6% 1.0%
2011 Equity Income 10.6% 13.5% 16.3%
2012 Capital Value 22.3% 43.9% 33.3%
2013 Explorer 44.4% 3.9% 12.4%
2014 PRIMECAP Core 19.3% — —
*Figures for Total Stock Market prior to inception are for the Wilshire 5000 index. Bold figures indicate superior performance in the given year.
>