(PUB) Investing 2016

The Independent Adviser for Vanguard Investors

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July 2016

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whether to focus here versus there is not

as easy as the sound-biters would have

you believe. Just look at the past eight or

so years on the aforementioned relative

performance chart. U.S. stocks have the

edge in performance over the full time

period—though in another six or seven

years that might change completely. Yet

it was anything but an easy victory. If

you can time those swings, you are far

smarter than I am.

Brexit in Focus

How does the Brexit fit into all of

this? First off, the fundamental and

philosophical reasons for having an

allocation to foreign stocks have abso-

lutely nothing to do with whether the

U.K. is part of the E.U. or not. Maybe

the Brexit vote has converted you to

Bogle’s way of thinking and you are

committing to own all U.S., all the

time. Okay. But if you own foreign

stocks today and are thinking of sell-

ing them because of the Brexit vote,

recognize that you are making a mar-

ket call—that foreign stocks are not

worth owning at this time. And you’re

making that decision after, not before,

they’ve taken a turn to the downside.

As I said above, I think market timing

is very tough. Not only do you have to

be right that this is the time to get out

of foreign stocks, but you also have to

figure out when to buy foreign stocks in

the future, because I know you’ll want

to do so when they start outperforming

U.S. stocks.

Make no mistake, global commerce

will continue. What exactly a new

agreement between the U.K. and the

E.U. will look like is unknown. Plus,

the U.K. will also have to renegotiate

treaties with other countries like the

U.S., China, India, etc. The U.K. is the

fifth-largest economy in the world, and

at 6.7% of Total World Stock Market

Index, is the third-largest stock market

after the U.S. and Japan. The U.K. is

Germany’s third-largest export mar-

ket, and the fifth-largest for Italy and

France. So its decision to leave the E.U.

is absolutely disruptive to the global

economy and markets.

This was reflected in the mar-

ket’s immediate reaction to the Brexit

vote: In the two days after the vote,

European Index

fell 13.6%, and the

pound sterling tumbled 11.1%, Total

Stock Market Index dropped 5.6%, and

the yield on the 10-year Treasury went

from 1.74% to 1.46%.

As you can see in the timeline on

page 14, the U.K. and the E.U. haven’t

always been on the same page. While

the June 23 vote led to some dramatic

changes in currencies, prices and expec-

tations, it doesn’t actually change

MULTIMANAGERS

Another Team Bites the Dust

VANGUARD HAS BECOME

the cheerleader for the “If one advisory team is good then two must

be better” philosophy underpinning its multimanager funds. In fact, the company’s recent web

posting trying to argue for multimanagers is something I took to task in the June 2016 issue of

the

Independent Adviser for Vanguard Investors

So, how to explain the June 6 announcement that one-third of

Explorer Value

’s three-

adviser portfolio team is being pink-slipped with no replacement named? Has Vanguard decid-

ed that, indeed, two management teams might be better than three? As you may recall, it was

only in January that Vanguard reduced the adviser counts on

Explorer

and

Morgan Growth

by one team each—though both remain, in my view, a multimanager mess.

I asked Vanguard, which offered no rationale for this change in its terse announcement, why

Sterling Capital Management was being let

go, and its responsibilities (assets) being re-

distributed to the remaining two management

teams at Frontier Capital Management and

Cardinal Capital Management.

They didn’t really give me an answer other

than to say that the fund’s trustees—none of

whom owned a single share in Explorer Value

at last report, by the way—had determined

the change would be in the best interests

of shareholders. Gobbledygook. Wasn’t the

original decision to put three management

teams on the fund, made when the fund was

launched a bit over six years ago in March

2010, in the best interests of shareholders?

So, the question remains: Was it something about Sterling’s investment staff, its investment

process or its performance? Vanguard won’t say, though they offered that all three were factors

it evaluates.

Jeff did some digging and couldn’t find any evidence that the company has been roiled by

personnel problems, and it’s unlikely that their process somehow changed all of a sudden.

But it could be that Sterling was the weak hand among the three management teams on the

performance front. Sterling’s portion of Explorer Value was measured, for performance bonus

purposes, against the Russell 2500 Value index of about 1,670 small-cap/mid-cap stocks. That

means Sterling’s combined mid-cap and small-cap stock picks were their grist for Explorer

Value’s portfolio, though the emphasis was probably upon the smaller stocks it chose.

Analyzing the performance of separate portfolios run by Sterling’s team members, Jeff found

that while performance of their mid-cap value strategies was fairly close to that of Explorer

Value’s overall, their small-cap value strategies were pretty poor, posting results that lagged

Explorer Value’s by 3.0% per annum and lagged

SmallCap Value Index

by 2.6% per annum.

Did Vanguard fire Sterling Capital Management for performance problems? They’ll never

tell, but as I said at the outset, the fact that they’ve trimmed Explorer Value’s management

teams by one-third puts a big question mark over Vanguard’s claim that more is better when

it comes to portfolio management teams. And it may be a sign of better things to come for

Explorer Value.

Sterling’s Small Value

Picks Lagged

3/10

9/10

3/11

9/11

3/12

9/12

3/13

9/13

3/14

9/14

3/15

9/15

3/16

Rising line = ETF outperforms

Explorer Value

Sterling Small Cap Value

Sterling Capital Mid Value A

Sterling Mid-Cap Value

SmallCap Value Index

100

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200

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