The Independent Adviser for Vanguard Investors
•
February 2016
•
5
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and markets don’t automatically shift
once the calendar turns from December
to January. And ignoring hot strate-
gies, or going with the “dogs,” as some
investment advisers who use a contrar-
ian approach like to suggest, can lead
Vanguard investors to market-lagging
and even negative returns. Dogs are
dogs for a reason. They make great
pets, but lousy bets.
But, let’s get back to the
Hot Hands
winners. Here are the ground rules for
the strategy as I originally set them
out in 1995 when I conducted the
first analysis (and when we owned
PRIMECAP
, 1994’s best fund, in our
Model Portfolios
). I’ve continued to
follow these rules and have updated
my research as new funds have been
introduced.
I have looked at the best and worst
Vanguard equity funds for each year
between 1981 and 2015. The funds
I exclude are sector funds, such as
Energy
,
Precious Metals & Mining
,
Health Care
, both of the REIT funds
and the old Utilities Income (now
Dividend Growth
, which I do include),
as well as the regional international
index funds,
Emerging Markets Stock
Index
,
European Index
and
Pacific
Index
,
since they are what I would
consider sector funds. I’ve also exclud-
ed the actively managed
Emerging
Markets Select Stock
. Plus, I don’t
consider balanced funds and
Market
Neutral
, which (besides having a pro-
hibitive investment minimum) is really
a hybrid fund.
However, I do include the diversi-
fied internationals in the mix. You see,
domestic funds have the right to invest
overseas, and, indeed, funds like
U.S.
Growth
or PRIMECAP can and have
owned foreign companies like Nokia
and Sony. And a fund like Global
Equity can invest in the U.S. So the way
I see it, international/global funds are
simply diversified equity funds invest-
ing in another portion of the world
stock market. We shouldn’t exclude
them. (I should mention that I do track
a
U.S.-Only Hot Hands
strategy as well,
and its record is also extremely good,
with an annualized return of 13.3%
versus the 11.1% return for the market.
The
U.S.-Only Hot Hands
fund for
2015 is the same as the
October Hot
Hands
pick, U.S. Growth.)
That’s the background. Now that
I have my universe of funds, I can
determine the “hot” fund each year,
follow it in the next year and compare
its return with the market benchmark.
When I make those comparisons, I
measure rolling three-year, five-year
and 10-year returns for the
Hot Hands
fund against Total Stock Market Index,
a proxy for the entire stock market,
rather than the average Vanguard fund
or the average stock fund.
Measuring performance against the
stock market, rather than the “average”
stock fund, puts even greater pres-
sure on the methodology to generate
decent returns, since the market gener-
ally outperforms the “average” money
manager. Why make my hurdle that
much harder to overcome? Because
I’m not interested in average perfor-
mance—you and I want outstanding
performance. And that’s what we get
with
Hot Hands
.
Long-Term Heat
Here’s the bottom line: Following
a
Hot Hands
investment strategy at
Vanguard from the end of 1981, when
you would have put your money into
Windsor
, through the end of 2015,
when your money would have been in
PRIMECAP Core, would have netted
you a total return of 13,720% compared
with a return of 3,523% for Total Stock
Market Index. Those are whopping num-
bers, but they simply reflect the power of
compounding over a 34-plus year period.
Playing the contrarian and buying
the previous year’s worst fund, how-
ever, has proven to be an awful idea.
Since 1981, the strategy would have
netted the investor an index-lagging
1,076% return. (That’s less than one-
tenth the
Hot Hands
gain.)
Long-Term Performance
Hot Hands fund
Total return
Following year
Total Stock Market*
1981
Windsor
16.8%
21.7%
18.7%
1982
SmallCap Index
46.4%
18.2%
23.5%
1983
International Growth
43.0%
-3.3%
3.0%
1984
Windsor
19.4%
28.0%
32.6%
1985
International Growth
57.0%
56.7%
16.1%
1986
International Growth
56.7%
12.5%
2.3%
1987
International Value
24.0%
18.8%
17.9%
1988
Windsor
28.7%
15.0%
29.2%
1989
U.S. Growth
37.7%
4.6%
-6.2%
1990
U.S. Growth
4.6%
46.8%
34.2%
1991
Explorer
55.9%
13.0%
9.0%
1992
Convertible Securities
19.0%
13.5%
10.6%
1993
International Growth
44.7%
0.8%
-0.2%
1994
PRIMECAP
11.4%
35.5%
35.8%
1995
Windsor II
38.8%
24.2%
21.0%
1996
Windsor
26.4%
22.0%
31.0%
1997
PRIMECAP
36.8%
25.4%
23.3%
1998
Growth Index
42.2%
28.8%
23.8%
1999
Capital Opportunity
97.8%
18.0%
-10.6%
2000
SmallCap Value Index
21.9%
13.7%
-11.0%
2001
Selected Value
15.0%
-9.8%
-21.0%
2002
Global Equity
-5.6%
44.5%
31.4%
2003
International Explorer
57.4%
31.8%
12.5%
2004
International Explorer
31.8%
20.5%
6.0%
2005
International Explorer
20.5%
30.3%
15.5%
2006
International Explorer
30.3%
5.2%
5.5%
2007
Growth Equity
22.5%
-47.9%
-37.0%
2008
Dividend Growth
-25.6%
21.7%
28.7%
2009
Capital Value
81.5%
20.2%
17.1%
2010
SmallCap Growth Index
30.7%
-1.6%
1.0%
2011
Equity Income
10.6%
13.5%
16.3%
2012
Capital Value
22.3%
43.9%
33.3%
2013
Explorer
44.4%
3.9%
12.4%
2014
PRIMECAP Core
19.3%
0.9%
0.3%
2015
International Explorer
8.6%
—
—
*Figures for Total Stock Market Index prior to the fund’s inception are for the Wilshire 5000 index. Bold figures indicate superior perfor-
mance in the given year.
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