The Independent Adviser for Vanguard Investors
•
May 2014
•
7
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at that point yet. Pzena has so far only
picked up a small portion of the port-
folio. But a jump to 120 stocks from 67
(which is a massive leap from the 40
stocks or so Barrow ran with original-
ly) is disheartening, as it means Pzena
probably has little to no overlap with
the stocks already in Selected Value.
I’ll stay the course for the moment, but
I’ve got my eyes on this one, and if this
kitchen’s soup begins to go bland, I’ll
let you know.
n
Interview
with Don in last month’s
issue, you probably know that the one
area of the market where he thinks the
most long-term value currently resides
is in the energy sector. Since the end
of 2013, the index fund’s allocation to
energy stocks has remained stagnant.
Kilbride, on the other hand, has a
higher allocation today than he did at
year-end.
Maybe it’s stock picking and maybe
it’s deliberate allocation of cash; either
way, it’s the kind of active management
that has stood the fund head and shoul-
ders over its index cousin.
n
TRY TO ANSWER THIS QUESTION
without jumping ahead to see the
answer: The two charts shown here
represent the industry/sector alloca-
tions for two funds benchmarked to
the exact same index. One fund’s
turnover over the past five years has
averaged 13%, while the other fund’s
average turnover has been 17%. What
can you say about these two funds? Is
one active and the other passive? Are
they both index funds or both active
funds?
Pretty confusing, right? One fund’s
portfolio allocations are all jiggly-jag-
gly while the other’s look fairly smooth
over time.
Let me give you the answer to the
question and then let’s discuss it.
Fund A is an index fund,
Dividend
Appreciation Index
. Fund B is an
actively managed fund,
Dividend
Growth
. Both are benchmarked to the
same index. While turnover is pretty
similar, the jagged shifts in allocations
in the index fund, Fund A, look more
like the work of an active hand versus
the more steady allocations in the active
fund, Fund B. Notice, for instance, the
disappearance of telecom stocks around
the end of 2008 and the leap in alloca-
tion to energy stocks in 2010 and 2011
in Fund A.
It just doesn’t make sense, initially,
that the allocations in an index fund
would bounce around the way they
have in Dividend Appreciation Index,
particularly when you compare it to
the relatively steady-state allocations
in Dividend Growth, until you consid-
er that the index fund is held to a very
particular rule set that requires it to
dump stocks of companies that haven’t
consecutively raised their dividends in
each of the past 10 years. That sounds
pretty “active” to me, since humans,
not computers, write those rule sets.
What got me started on this bit of anal-
ysis were some comments in Vanguard
Chairman Bill McNabb’s recent letter
to Dividend Appreciation Index’s share-
holders. He noted the fund benchmark’s
rule set, and also mentioned that sector
allocations could and would differ from
the broad stock market as a result. What
he didn’t mention was that the changes in
the index composition can be very, very
abrupt, something that seems anathema
to the indexing dogma that pervades
Vanguard. But since changes are made at
year-end and index-tracking funds must
make their changes right away to stay
in sync, that’s exactly what happens at
Dividend Appreciation Index.
Meanwhile, the active portfolio
management that is derided so often
by Vanguard actually looks a lot less
active in the hands of Don Kilbride at
Wellington Management. You have to
ask why the index fund’s average turn-
over is only a few percentage points
away from Kilbride’s. Sounds pretty
active to me.
And what does all that activity get
you? Not a lot. In fact, if you read the
INDEXING
Smooth Sailing?
Dividend Growth vs. the Index
2/06
2/07
2/08
2/09
2/10
2/11
2/12
2/13
2/14
0.96
1.00
1.04
1.08
1.12
1.16
rising line
= Dividend Growth outperforms
Dividend Appreciation Index
Fund A: Annual Reallocation
2/07
2/08
2/09
2/10
2/11
2/12
2/13
2/14
0%
20%
40%
60%
80%
100%
Utilities
Telecom
Materials
Info Tech
Industrials
Health Care
Financials
Energy
Consumer Stap.
Consumer Disc.
Fund B: SmoothManagement
2/07
2/08
2/09
2/10
2/11
2/12
2/13
2/14
0%
20%
40%
60%
80%
100%
Utilities
Telecom
Materials
Info Tech
Industrials
Health Care
Financials
Energy
Consumer Stap.
Consumer Disc.
