(PUB) Investing 2015

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4 • Fund Family Shareholder Association
LACKING A GO-ANYWHERE bond
fund, Vanguard seems to be making it
a priority to find fault with managers
who run “unconstrained” or “flexible”
income funds that invest in both gov-
ernment and corporate bonds across
a broad range of maturities and credit
quality along with other more esoteric
bonds from, say, emerging markets.
The latest is a missive that attempts
to enumerate the risks inherent in a
fund that gives the manager leeway to
QUOTABLE
Vanguard Doth Protest Too Much
pick and choose allocations to various
bond asset classes. But the line that got
me was Vanguard’s observation that
“investors lose control over their asset
allocations” in such funds, and this
means that the “underlying risk expo-
sures can become difficult to identify
in advance.”
What’s funny is that this is pre-
cisely what has been going on at the
Managed Payout funds for years, as
Vanguard’s management team chose to
add to and subtract from various asset
classes without advance warning.
During the days when Vanguard was
running three Managed Payout funds,
allocations to broad classes like U.S.
stocks ranged from 25.1% to 50.7%
of assets. Commodity exposure ran
from 2.3% to 12.2%. REITs could be
4.9% of a portfolio or 10.6%. Today’s
Managed Payout, the agglomeration
of the assets in the prior three trial
funds, has been in its current form for
a bit more than a year, but allocations
to intermediate-term investment-grade
bonds went from 4.9% to zero as the
fund grabbed hold of a larger allocation
to U.S. Treasurys through Total Bond
Market II (an institutional version of
Total Bond Market). U.S. stock expo-
sure through Total Stock Market has
ranged from a high of 25.7% to 20.9%,
all over the course of a few months.
Also, consider the shifting tides
underneath other Vanguard funds-of-
funds. While asset allocations tend to
remain stable from one month to the
next, Vanguard has made several course
corrections to its own asset alloca-
tion objectives in various funds, as
the recent decision to go with a 40%
allocation to foreign stocks and 30% to
foreign bonds in its Target Retirement
funds makes clear.
Some unconstrained, flexible, go-
anywhere income funds will of course
falter, and their high expenses will be
just one factor tripping them up. Others
will not. It’s just like choosing a good
stock fund: Watch the manager, and
watch the fees.
Vanguard should know better than
to cast stones, however, when they also
offer up some glass houses with less-
than-transparent windows. n
QUOTABLE
“SO, WHAT DOES HE LIKE NOW?” asked Kiplinger’s 10 years ago of Joe Brennan, then a prin-
cipal in Vanguard’s portfolio review group. Brennan’s reply: Large-cap growth, and in particular
U.S. Growth and Growth Equity.
Well, we all know what happened to Growth Equity. The fund cratered under the man-
agement horrors of Turner Investment Partners, and after years of waiting for a turnaround,
Vanguard finally gave up and folded its remaining assets into U.S. Growth last year, forever
relegating Growth Equity’s performance history to the dustbin of time.
But what of U.S. Growth over the period since Brennan was pounding the table for the fund
over and over? (Yes, he continued to defend the fund’s horrible underperformance and its man-
agers as questions continued to fly over why the fund was doing so poorly.)
Well, between April 2005, when Brennan was recommending U.S. Growth, and the end of
March 2015, a decade over which numerous managers have come and gone, the fund returned
132.3%, or 8.8% per annum, which is about 0.4% per annum ahead of Total Stock Market’s
8.4% gain. That might be all fine and well, except that Growth Index, that plain-vanilla large-
cap growth fund which hasn’t been burdened by a merry-go-round of managers, gained 142.3%,
or 9.3% per annum over the same period.
More to the point, if you were looking for excellent active management in the large-cap
growth arena, it would have paid to have focused on either PRIMECAP or PRIMECAP Core,
which gained 10.8% and 10.7%, or 178.4% and 176.0%, respectively, over the decade.
Kiplinger’s wrote that it didn’t pay to bet against Brennan’s picks. “After all, who knows these
managers better than he does?”
I won’t bother answering that question, as the numbers tell the tale, but I will say that there’s
an inherent problem in asking a Vanguard executive to recommend a Vanguard fund, because
neither you nor I can know what internal bias, corporate bias or external factors are influencing
the recommendations. For instance, was a recommendation to buy a chronic underachiever an
attempt to staunch the flow of assets out of the portfolio? Or was it a means to deflect atten-
tion from better-performing funds like PRIMECAP Core, which was then still open to new inves-
tors but might have been attracting too many dollars despite its higher expenses, something
that flies in the face of the indexing dogma that has driven Vanguard’s growth?
As Vanguard heads further and further into the advice business, no matter how low their
fees, it will pay to remember that not only is there no free lunch, but even a cheap one may cost
you more than you know.
Vanguard’s Call on U.S. Growth
When Vanguard was
running three Managed
Payout funds, allocations
shifted regularly.