12
•
Fund Family Shareholder Association
each index tracked by Vanguard’s sec-
tor funds and ETFs along with the
returns from the Wilshire 5000 index (a
measure of the overall stock market) for
the last 10 calendar years, in descend-
ing order. The only pattern I see is that
the Wilshire 5000 index never comes
out at the very top or falls to the very
bottom, which is what we would expect
from a diversified portfolio. If you can
discern another pattern, then you may
have a career awaiting you in the cipher
division of the military.
Second, but not unrelated, if you
are going to try your hand at being an
active sector investor, you’d better have
a very well-defined and well-conceived
strategy guiding you—one which you
are prepared to stick to through thick
and thin, because invariably there’ll be
plenty of times your method doesn’t
work. I don’t say that to knock any par-
ticular strategy, but out of acceptance
of the fact that no strategy works all
the time. And if you aren’t following a
disciplined strategy, you really are just
speculating—and likely to get burnt.
The first five months of 2014 have
illustrated just how difficult it can be to
correctly and profitably weave in and
out of various market sectors. Though
the overall U.S. stock market is pretty
much where it started the year—
Total
Stock Market
is only up 4.3%—there
has been an active rotation of buying
and selling under the surface. The chart
above shows Vanguard’s sector fund
returns for 2013 as well as the first five
months of 2014. A number of last year’s
laggards, like
REIT Index
,
Utilities
Index
and
Energy Index
, are lead-
ing the way, while some of last year’s
leaders, like
Consumer Discretionary
Index
, are trailing.
Despite the warnings that past per-
formance isn’t indicative of future
returns, the lure of past returns is all
too often tempting for many inves-
tors, drawing them in at just the wrong
time. Let’s look at just one recent
example: Over the 12 months end-
ing February 2014,
Health Care
and
Health Care Index
returned 47.4%
and 41.5%, respectively, outpacing
Total Stock Market’s 26.7% return by
wide margins. Investors and traders
responded by pouring record amounts
of money into the two health care funds
in February: $193 million cascaded
into Health Care, making it the single
largest month for inflows in a decade,
while $366 million flooded into Health
Care Index, an amount that was more
than twice that of its best month prior to
that. Since the end of February, Health
Care is down 0.3% and Health Care
Index is off 0.6%, while Total Stock
Market has gained 2.8%. That’s not a
complete disaster, but it’s probably not
what investors were expecting when
they traded into the funds with their
eyes on the 40%-plus returns in the
rear-view mirror.
Of course, a disciplined approach to
sector investing doesn’t have to involve
trading between sectors—you could
partner with a sector for the long term. In
fact, you and I have done very well focus-
ing on one excellent sector: Health care.
We have also benefited from the standout
team at Wellington Management that
runs Health Care, or the equally excep-
tional
Hartford Healthcare
(HGHAX),
which I recommend as an alternative if
you can buy it without a load.
Still, the unfortunate truth is that
most people shouldn’t even consider
investing in sector funds to begin with.
Vanguard’s Sectors
If sector investing increases the risk
of poor investor behavior, not to men-
tion that it seems anathema to the
Vanguard tradition of buy-and-hold and
broad index diversification, why does
Vanguard offer investors sector-specific
funds in the first place? The simple
answer: It’s another way to grow assets.
And with roughly $115 billion in assets
under management, Vanguard’s sector-
specific funds and ETFs have been a
good business for Vanguard.
Still, Vanguard has always been
somewhat bipolar when it comes to
sector investing. Alongside the energy,
health care and precious metals funds,
which opened 30 years ago in May
1984, Vanguard founder Jack Bogle also
introduced funds investing in what he
called the “service economy” and tech-
nology. Both of those actively managed
FOCUS
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>
Crazy Quilt of Returns
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
39.9%
35.3%
45.6%
34.4% (16.4%)
62.2%
30.9% 19.1% 40.9% 43.7%
33.2%
17.4% 37.3%
26.5% (23.4%)
51.8% 28.5% 14.0% 26.4% 42.8%
31.5%
15.0%
35.9%
17.5% (28.0%)
47.5%
27.4% 10.7%
24.9%
42.1%
23.3%
13.0%
21.7%
15.1%
(33.2%)
46.8%
24.6% 8.7% 19.2%
34.0%
19.3% 8.5% 21.0% 13.9% (36.9%)
29.4%
21.0%
4.5% 18.7%
33.1%
18.8% 6.3%
19.8% 13.4%
(37.3%)
28.6%
17.9% 3.8%
17.8% 31.1%
16.9% 6.3% 19.5%
10.5%
(38.0%)
22.5%
17.7%
3.5% 17.5% 27.4%
14.1%
4.9%
16.8%
8.0%
(38.0%)
22.2%
17.2%
0.7% 17.2% 25.7%
13.9% 4.5%
15.9% 5.7%
(39.9%)
19.4% 14.9%
0.6% 16.1%
25.0%
12.6%
3.9% 15.0%
1.9%
(42.8%)
15.6% 14.5% (2.0%)
14.2%
15.1%
9.3% 3.1% 14.7%
(11.4%)
(46.7%)
14.4% 12.8% (9.3%)
10.9%
14.7%
4.4%
(2.1%)
9.2% (16.8%)
(49.1%)
12.6% 7.2%
(14.2%)
3.6%
4.4%
1.7%
(4.1%)
6.8% (17.3%)
(53.0%)
11.7%
6.0%
(16.0%)
2.1%
2.5%
n
Wilshire 5000
n
MSCI Consumer Discretionary
n
MSCI Consumer Staples
n
MSCI Energy
n
MSCI Financials
n
MSCI Health Care
MSCI Industrials
n
MSCI Info. Tech
n
MSCI Materials
n
MSCI REIT
n
MSCI Telecom
n
MSCI Utilities
n
S&P Global ex-U.S. Property
Market Rotation
Consumer Disc. Index
Health Care
Health Care Index
Total Stock Market
Financials Index
Info. Technology Index
Consumer Staples Index
Energy Index
Materials Index
Telecom Svcs. Index
Energy
Utilities Index
Global ex-U.S. R.E. Index
REIT Index
-40% -30% -20% -10% 0% 10% 20% 30% 40% 50%
Prec. Metals & Mining
2013 Return
2014 YTD Return
