(PUB) Investing 2015

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The Independent Adviser for Vanguard Investors • March 2015 • 5 FOR CUSTOMER SERVICE, PLEASE CALL 800-211-7641
The rapid growth companies’ prospects are higher risk, less certain,
particularly than the growth stalwarts. We think in today’s market envi-
ronment, investors are not fully appreciating those sorts of companies
because of the element of uncertainty. The likes of Amazon or Google we
consider to be attractively priced at the moment and in both cases have
added to over the last few months.
The next growth category is “cyclical growth.” The first two [categories]
I talked about typically are regular year-on-year growers—they either have
it or they haven’t. It doesn’t tend to go up or down with economic cycles.
Whether GDP is 2% or 3% is not really going to have a noticeable differ-
ence to Amazon. Whereas if you are a highly geared [leveraged] bank, you
are geared into GDP—there is a cyclical element to it. So these companies
don’t grow every year, and they may not be growing at the moment, but
we can see through the cycle that they can add value and outperform their
peers. Our cyclical exposure is very often in companies that try and benefit
by investing at the bottom of a cycle and holding off at the top.
The last is “latent growth” stocks, which are companies that have
minimal operational momentum. Their last five years, maybe even 10
years, looks pretty terrible, but we believe there can be a growth stock in
there waiting to get out. A change either on the supply side or the indus-
try structure or the demand environment or maybe through a technology
means the future is going to be very different from the past. There aren’t
so many of these because real dramatic change doesn’t happen to very
many industries or companies at any one time, but when we can find
them, we are very excited.
Can you give me an example?
Only this morning I had a meeting with [a latent growth company],
one of the biggest Japanese non-life insurance companies, MS&AD.
That industry has gone from 18 players to three over the last 15 years.
These three players have 90% of the market between them. This bodes
very well for future pricing, competition and returns because all three are
focused on profitable underwriting. No one is fighting for market share—
so it’s all about profits now, and that is very different from the history.
How many stocks do you currently own and in what kinds of
weights?
It’s 96 stocks at the moment. There has been [virtually] no change over
the last four or five years. I wouldn’t really expect any dramatic change in
the number of holdings.
>
ASWE OFFICIALLY ENTER the seventh
year of a very, very strong bull market
in stocks, it’s only natural for investors
to look back and say “if only”—as in,
“If only I had invested all my money
in [insert the current hot asset class],
I would be sitting pretty.” This is a
potentially hazardous game to play as it
discourages investors from sticking to a
core investment tenet—diversification.
Today the hot asset class is U.S.
stocks. Since the end of February 2009,
which marked the month-end bottom of
the Great Recession’s bear market, 500
Index has gained 231.9%, or nearly
double Total International Stock ’s
124.2% gain.
No doubt this raises the question of
why, given the strong outperformance
of the U.S. stock market, and all the
negative headlines overseas, investors
would even consider investing beyond
of our shores. I’ve noticed a new “com-
mon wisdom” that diversifying your
portfolio to hold foreign stocks is sim-
ply a losers’ game. I firmly disagree.
Consider the chart above that shows
the difference in performance between
U.S. stocks (as measured by the S&P
500) and foreign stocks (as measured
by the MSCI EAFE) over the past
31 calendar years. You’ll notice that
last year saw the largest divergence
between U.S. and foreign stock returns
since 1997.
But also look for a couple of other
things. The largest single year of diver-
gence between U.S. and foreign stocks
took place in 1986, when foreign stocks
outperformed U.S. stocks by more than
50%. Also, note that foreign stocks
outperformed U.S. stocks in all but one
year from 2002 through 2009.
U.S. stocks have outperformed in
four of the last five years. 2014 saw
huge gains in the U.S. market relative
to foreign markets not so much because
say, Europe’s and Asia’s markets didn’t
rise—some did, with Germany up
almost 3% and Japan up more than
7%—but because the dollar strength-
ened against the euro and yen.
I know I am at risk of kicking a dead
horse with this story, but diversification,
though often met with derision, works
in the long run and is one of the building
blocks of my approach to investing. At
some point, foreign stocks will lead U.S.
stocks, and the dollar will weaken against
other currencies. Maybe we are starting to
see that already, with Total International
Stock leading 500 Index 5.7% to 2.5% so
far in 2015. Or maybe this is just a two-
month blip, and U.S. stocks will regain
their leadership role. Rather than try to
guess which scenario plays out, I’d rather
stay diversified, knowing that I am posi-
tioned to benefit whichever way the story
unfolds. n
INTERNATIONAL
Stick With the Basics
U.S. vs. Foreign Stock
Return Gaps
12/8412/8712/9012/9312/9612/9912/0212/0512/0812/1112/14
-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40% U.S. Stocks Outperformance Gap
U.S. Stocks Underperformance Gap