(PUB) Investing 2016

551 / 708

The Independent Adviser for Vanguard Investors • February 2016 • 5 FOR CUSTOMER SERVICE, PLEASE CALL 800-211-7641
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.
>