(PUB) Investing 2016

The Independent Adviser for Vanguard Investors

•

February 2016

•

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800-211-7641

HAS VANGUARD FINALLY

figured out

what I’ve been saying for years, that

too many cooks spoil the multimanaged

fund broth?

In early January, Vanguard reduced the

headcount on both

Explorer

and

Morgan

Growth

, two of the poster-children for

excessive multimanagement. This is

good news for the funds’ shareholders.

But I don’t think they went far enough.

Vanguard continues to claim that throw-

ing lots of different management teams at

a single portfolio is smart active manage-

ment, but I beg to differ.

In the latest manager musical chairs,

Century Capital Management was fired

from Explorer and leaves the Vanguard

fold, while Kalmar remains a manager

on Explorer but has been relieved of its

role on Morgan Growth.

This reduced the headcount on

Explorer to seven management teams

made up of 15 individual portfolio man-

agers, while Morgan Growth will now

be served by four teams totaling eight

portfolio managers.

Vanguard says that the multimanager

format, which it first adopted in 1987,

“can reduce portfolio volatility, provide

potential for long-term outperformance,

and mitigate manager risk.”

I’d say they are batting, at best, one

out of three.

Let’s take performance.Two charts tell

the tale here. The first shows Explorer’s

relative performance against its Russell

2500 Growth index benchmark. The

persistent downtrend confirms what I’ve

been saying for some time.

You can pretty much say the same

thing for Morgan Growth. While its

performance lately has mimicked the

Russell 3000 Growth index, that’s little

comfort for its shareholders. You can see

that as Vanguard kept adding manag-

ers, performance suffered. Why bother

investing here?

As for multiple managers reducing

risk, Vanguard might want to talk about

betas and standard deviations and all

that market mathematics, but I think

we should use a simple metric, one that

really relates to shareholder experience:

Maximum Cumulative Loss (MCL), or

drawdown.

During the 2008–2009 financial cri-

sis, Explorer investors suffered a 52.4%

loss over 16 months ending in February

2009. It took 24 months for the fund’s

managers to recover that loss. SmallCap

Growth Index suffered a 53.5% loss over

the same period and took 22 months

to recover. Is the difference between a

52.4% loss and a 53.5% loss really risk

management? And given the fact that the

index fund recovered faster, I’d say that,

at best, the two funds came to a draw.

As for Morgan Growth, the fund’s

shareholders lost 50.3% during the finan-

cial crisis over 16 months. That loss

was recovered in 37 months. Extended

Market Index investors lost a bit more,

52.9% over 21 months, but recovered

much quicker, taking 22 months. Again,

is the difference between a 50.3% loss

and a 52.9% loss worthy of the claim

that multimanagement reduces risk? One

could counter that the index fund’s faster

recovery more than outweighs the ben-

efits of the slightly smaller decline.

As for the final “benefit” of multi-

management, the reduction of “manager

risk,” well, that’s kind of obvious, isn’t

it? If Vanguard doesn’t hire managers

who all invest in the exact same stocks

and in the same fashion, and they hire a

bunch of them, then

ipso facto

, you can

claim lower manager risk. But what’s the

benefit?

I should note that at the end of 2014

(the last year for which data is available),

only two of Vanguard’s nine directors

owned shares in Explorer, and only one,

Bill McNabb, owned shares in Morgan

Growth (and not too many, at that). So,

Vanguard’s directors really don’t have a

lot of skin in the game when it comes to

these two multimanaged messes.

Vanguard needs to do more to reduce

the head-count on its multimanaged

funds. Shareholders have mutinied, as

neither fund has seen investor inflows

in any of the last seven calendar years,

a record only matched by

Growth &

Income

Windsor

and

Windsor II

, all

of which are domestic stock funds, open

to new investors and multimanaged.

I will give Vanguard credit for tacitly

admitting they’ve gone overboard.

On the Other Hand

While Vanguard was cutting manag-

ers at Explorer, in another announce-

ment it added two portfolio manag-

ers from Arrowpoint Partners to

Small

Company Growth Annuity

. This

small-cap growth annuity is only run

by a fraction of Explorer’s managers

and has outperformed the more man-

ager-laden fund, which to me is further

evidence that adding managers doesn’t

improve performance. We’ll have to see

if the addition of Arrowpoint sharpens

the annuity’s returns, or dulls them.

MULTIMANAGERS

Vanguard Trims Its Ranks

Explorer vs. Russell 2500

Growth Index

12/05

12/06

12/07

12/08

12/09

12/10

12/11

12/12

12/13

12/14

12/15

Rising line = Explorer outperforming

0.80

0.85

0.90

0.95

1.00

1.05

Firm hired

Firm fired

Morgan’s Many Managers

12/88

12/91

12/94

12/97

12/00

12/03

12/06

12/09

12/12

12/15

Rising line = Morgan outperforming Russell 3000 Growth Idx.

Roll &

Ross fired,

replaced by

Vanguard

internal

▼

Morgan's

first two

multimanagers,

Franklin and Roll

& Ross, added

▼

Husic

added as

fourth

manager

▼

Kalmar

and Frontier

replace Franklin.

Morgan now has

five management

teams.

Jennison hired as

fourth team

Husic

fired

0.60

0.70

0.80

0.90

1.00

1.10

1.20

1.30

▼