The Independent Adviser for Vanguard Investors
•
August 2014
•
3
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market, it doesn’t always work out that
way. Consider, for instance,
Health
Care
’s 28.9% return over the past 12
months. Does this mean we have been
in the grips of an early bear market for
a year? I don’t think so.
In fact, there’s a very good chance
we are still very much mid-cycle in the
economic recovery as well as the stock
market’s rotation. And about that rota-
tion, Jeff’s analysis shows that there
really isn’t much of a pattern you can
hang your hat on. I would hate to build
a portfolio of certain market sectors, and
then hope to trade through them while
guesstimating our position in the eco-
nomic and market cycle. From what we
see in the data, there’s no “there” there.
And if you flip it around and try to figure
out where we are in the cycle by what’s
doing well now and what’s faded in
recent months, well, good luck with that.
As I said, I think this long, slow
grind means we are well into the middle
of the economic and market expansion.
Do I know how long this mid-cycle
phase will last? No. Does it make me
want to change our portfolios or adjust
our investments? Absolutely not.
On to other things: The SEC finally
made a decision about money funds, and
the good news for you and me is that we
can continue to rely on our funds being
priced at $1.00 per share day in and day
out: No variable pricing for us individu-
als. The SEC also gave money funds the
ability to suspend redemptions for up to
10 days if panic selling gets in the way
of orderly management of a fund. For
institutions, it’s more complicated, but
for Vanguard investors like us, I think
this is a non-event. The yields may be
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GRIND
FROM PAGE 1
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horrid, but our Vanguard money funds
are safe and well-run.
On another note, the “inversion”
trend, which has been picking up
momentum this year, is now finally on
policymakers’ radar in Washington. In
sum, U.S. companies are increasingly
seeking out foreign firms for mergers
with the explicit objective of using the
acquisitions to reincorporate in foreign
countries where corporate taxes are
lower. Say what you will about tax-
avoidance schemes and the fact that
these companies are benefiting from all
the services U.S. taxes pay for without
contributing their fair share, but what’s
gotten short shrift in the media is the
tax impact on you and me. That’s right,
us, the small investors.
When a company completes an inver-
sion, U.S. investors must recognize all
of the taxable gains in that company’s
stock. It’s as if you sold the stock, or for
fund shareholders, it’s as if your mutual
fund sold the stock—which means that
there could be a heavy tax to pay come
2015 if more and more inversion trans-
actions take place before year-end.
Mutual fund companies in general
have been quiet on this issue. In May,
when it still appeared that Pfizer would
complete an inversion transaction with
AstraZeneca, I asked Vanguard what
the capital gains exposure would be for
shareholders given that, at the time, Pfizer
was the ninth largest holding across all of
Vanguard. They never came up with an
answer, but I can virtually guarantee you
it would have been a whopper.
Pharmaceutical companies have
been particularly active in this arena.
Pfizer could still be in the hunt, and
as the 13th largest of the approximate-
ly 4,000 different holdings across the
Vanguard complex according to the lat-
est data I’ve seen, it’s almost certain to
give index fund investors agita. Another
company, Medtronic, is the 57th largest
holding, and Abbott Labs is the 60th.
(Yes, those invested only in IRAs or
other tax-deferred accounts can ignore
this.) I’ve wondered about Health Care,
with a net 45.2% of its portfolio show-
ing unrealized capital gains. Obviously,
its portfolio is loaded with pharma
stocks. The PRIMECAP team also has
a lot of health care exposure.
While the impact of inversions on
mutual fund investors has not yet made
waves, the swells may come during
December’s distribution season. And
no, I won’t be selling Health Care or
any of the PRIMECAP-managed funds
to avoid a potentially large distribution.
Remember, selling a fund creates its
own tax liability. But I certainly will be
keeping my eyes and ears open.
Finally, Vanguard removed the front-
and back-end loads on
World ex-U.S.
SmallCap Index
, a fund I believe is
a worthy competitor to
International
Explorer
in the overseas arena. Since
the index fund’s inception a bit more
than five years ago, it’s up 135.1%
versus International Explorer’s 141.5%
gain. I have a
Hold
on both as I expect
the team at
International Growth
to
give us at least some exposure to faster-
growing companies overseas.
n
We are still very
much “mid-cycle” in
the economic recovery
as well as the stock
market’s rotation.
