(PUB) Investing 2015

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14 • Fund Family Shareholder Association
flagship 500 Index, which tracks the
S&P 500 index. At the end of 2014,
you might have looked at the fund’s
20.2% three-year annualized return
and compared it to the actively run
Dividend Growth, where manager
Donald Kilbride had generated a 17.5%
annualized return over the same period.
With a higher return for the three years
through 2014, you might have con-
cluded the index fund was the preferred
option. Yet, had the investor compared
the two funds one year earlier, he would
have drawn the opposite conclusion.
Rather than using a static three-year
measure, though, a rolling-return cal-
culation shows that since taking charge
of Dividend Growth in February 2006,
Kilbride’s average three-year return of
8.3% was fully 1.6% better per annum
than the index fund’s. In fact, sev-
eral active managers running low-cost
Vanguard funds have similarly beaten
the index benchmark.
The same benefits that accrue to
index fund investors, such as low oper-
measure performance over one stat-
ic, artificial time period simply doesn’t
reflect the investor experience.
The solution is to look at multiple
time periods to accurately measure fund
performance that more closely aligns
with an investors’ true experience. For
instance, over a full decade, there are
actually 61 different five-year periods,
85 three-year periods and 109 one-year
periods you can measure if you roll
forward month by month. Using “roll-
ing returns” analysis, something Jeff
and I do all the time, is just one way to
raise your odds of finding active fund
managers who have outperformed and
will continue to outperform the market
or their benchmarks consistently.
In addition, investors can narrow
their search by building portfolios of
funds that share the same characteris-
tics as the best index funds—low costs
and diversification. One need look no
further than the content of this letter
and the Vanguard fund family for proof.
Consider, for example, Vanguard’s
ating costs and low turnover, can be
found at funds run by human manag-
ers—you just have to look for them.
Comparing the performance of every
portfolio in the mutual fund universe
to a single index over a single period
of time is a poor substitute for careful,
considered research seeking to find the
best flesh-and-blood managers on and
off Wall Street.
Investors can choose expediency
and simply buy an index fund, but
experience shows that spending a lit-
tle time focusing on one of the most
important financial decisions you will
ever make to find smart, capable and
consistently superior active fund man-
agers could mean the difference of
tens of thousands, if not hundreds of
thousands of dollars in retirement. As
Vanguard founder Jack Bogle has writ-
ten, “Seemingly small differences in
annual rates of return can result in enor-
mous differences in total return over
long periods of time. Do not ignore the
magic of compounding.” n
>
portfolio is more nuanced.” So, while a
substantial portion of investors’ curren-
cy risk is hedged at Managed Payout,
Vanguard has decided that for set-it-
and-forget-it investors, the target mar-
ket for the Target Retirement and STAR
Lifestrategy funds, it is better to take on
currency risk than to hedge it.
Get Active
Getting back to Global Minimum
Volatility, there is a third factor to keep
in mind: This is an actively managed
fund. Currently, the fund holds 400 or so
stocks, compared to the roughly 7,000
stocks that Total World Stock holds.
With a turnover just shy of 50%, Global
Minimum Volatility’s portfolio is far
from static. In just 15 months of life, the
allocation to European stocks has ranged
from 16.5% to 23.7% of assets. Or con-
sider the allocation to Japan, which has
swung from 3.1% to 7.2% of assets.
On top of the active component, the
minimum volatility focus has led to
some sector biases relative to a tradition-
al index that have so far been persistent.
In the table above, Global Minimum
Volatility is overweight higher-yielding
sectors like utilities, real estate and
communication services compared to
Total World Stock and Global Equity.
So make no mistake, the fund man-
agers are very active, and their portfolio
looks very different from Total World
Stock Index. As a result, I expect its
performance to be different—at times
for the better, and at times for the worse.
One thing that I think is important to
acknowledge is that the three manag-
ers, who co-manage 12 Vanguard funds
in all, have a dismal record of investing
alongside shareholders (though one of
them has some serious skin in Global
Minimum Volatility’s game). None of
the managers are invested in nine of
the 12 funds they work on—includ-
ing Strategic Equity and Strategic
Small-Cap Equity, where they man-
age the entire portfolio as opposed to
only a portion of it. Stetler has noth-
ing invested in any of the funds he
manages. Michael Roach has between
$50,001 and $100,000 in both Windsor
II and Explorer. However, he only has
a token investment of no more than
$10,000 in Global Minimum Volatility,
while Troyer has a meaningful invest-
ment of $500,001 to $1 million in it. At
least one of the managers is showing
some conviction in the strategy.
Going Forward
Bringing it back to where I started,
Global Minimum Volatility has got-
CONVENTION FROM PAGE 7 >
Vanguard Global Funds’
Sector Tilts
Global
Min.
Volatility
Global
Equity
Total
World
Stock
Basic Materials 2.8% 4.0% 6.0%
Communication Svcs. 7.9% 3.4% 4.4%
Consumer Cyclical 13.7% 13.3% 11.5%
Consumer Defensive 14.5% 9.7% 9.4%
Health Care 12.6% 10.2% 12.0%
Industrials 14.9% 12.7% 11.6%
Real Estate 7.9% 1.6% 4.0%
Technology 6.0% 17.0% 13.3%
Energy 2.7% 4.5% 7.1%
Financial Services 9.2% 22.7% 17.2%
Utilities 7.7% 0.8% 3.4%
Source: Morningstar.