(PUB) Investing 2016

614 / 708

4 • Fund Family Shareholder Association
WHAT COULD VANGUARD do better?
That’s the question Dan and I asked
ourselves a few months back. Last
month we discussed four areas where
Vanguard could up its game. And as
promised, here are six more places we’d
like to see Vanguard improve.
5. While Vanguard likes to tout num-
bers showing that index funds outper-
form active funds, that’s not the case
for Vanguard’s active funds, which,
like index funds, are low-cost.
The argument that index funds will
outperform the average actively man-
aged fund after fees makes sense. In
aggregate, all actively managed funds
roughly make up the market, and if
their expenses are higher than those for
index funds, which also make up the
market, well then, the index funds come
out ahead. And the numbers back this
up. Consider that over the past decade,
500 Index and SmallCap Index out-
performed roughly 80% of the funds in
their respective peer groups.
But at Vanguard, actively managed
funds aren’t run at high or even average
costs, but at low costs—not quite as low
as Vanguard’s index funds, but darned
close. The cost advantage that index
funds have over active funds is narrow-
er within the Vanguard stable. By my
count, through the end of 2015, half of
Vanguard’s actively managed domestic
and foreign stock and balanced funds
outperformed in-house index competi-
tors over the prior decade (or since
inception if the active and passive funds
were not around for 10 years). That’s a
pretty decent track record relative to the
mutual fund industry at large.
More importantly, it’s not a bad record
considering that it includes the likes of
Explorer and U.S. Growth, which I
have long said were overmanaged mess-
es. Funds that outperformed include
all the PRIMECAP Management-led
funds, Health Care, Dividend Growth
and International Growth—funds Dan
and I have recommended for many years
in the Model Portfolios. Not only can
active management outperform passive
index funds, but it is possible to identify
those managers ahead of time. We’ve
done it for years.
6. Vanguard says its multimanager
format, first adopted in 1987, “can
reduce portfolio volatility, provide
potential for long-term outperfor-
mance and mitigate manager risk.”
I’d say they are batting, at best, one
out of three.
To take just one example, Explorer
is the poster child for Vanguard’s failed
multimanager efforts, with 15 managers
from seven different firms (and that’s
after Century Capital was dropped from
the fund in January).
The chart below plots the rela-
tive performance of Explorer versus
the Russell 2500 Growth index since
Kalmar was added as the sixth sub-
adviser a little more than a decade ago.
When the line is rising, Explorer is out-
performing. You can see pretty clear-
ly that for all the manager additions
and subtractions, it’s been a persistent
downtrend for Explorer. Strike one.
Strike two concerns that claim about
reducing risk. To give just one example,
in the 2008–09 financial credit crisis,
Explorer suffered a 52.4% loss over 16
months ending in February 2009, which
took 24 months to recover. The Russell
2500 Growth Index suffered a nearly
identical 52.8% loss over the same period
(though that doesn’t include a manage-
ment fee) and recovered in 22 months. I’d
call that a draw in terms of risk.
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? They haven’t reduced the
risk that really matters (drawdown),
and they haven’t outperformed. Why is
multimanagement a good idea?
7. Vanguard is more concerned with
pulling in assets than preserving per-
formance.
A corollary to the weakness of
Vanguard multimanager strategy is the
fact that Vanguard would rather add
more managers to their most popular
active funds and keep them open to pull
in assets, rather than close them to pre-
serve their outperformance. In fact, if the
conglomerations only match their index
benchmarks, Vanguard is happy enough.
Mae West wasn’t talking about
Vanguard when she said, “If a little
is great, and a lot is better, then way
too much is just about right!” But she
could’ve been describing Vanguard’s
approach to the multiple manager for-
mat. Yes, there can be a benefit to own-
ing different managers, particularly if
they are hunting in different waters—as
Dan and I recommend in the Model
Portfolios. But you can easily go over-
board when adding managers to a sin-
gle portfolio when all are essentially
dropping their hooks in the same small
area, be it small-cap stocks or large-cap
dividend payers.
Adding multiple managers to a
fund makes the active fund look more
and more like the index it’s trying to
beat. Another way of thinking of it
is that with multiple managers you
reduce the chance of a really bad out-
VANGUARD
10 Things Vanguard Won’t Tell You—Part II
Explorer vs. Russell 2500
Growth Index
12/05 12/07 12/09 12/11 12/13 12/15
Rising line = Explorer outperforms
Firm hired
Firm fired
0.80
0.85
0.90
0.95
1.00
1.05