(PUB) Investing 2016

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14 • Fund Family Shareholder Association
SEPTEMBER’S END marks five years
since Vanguard completely revamped
Growth & Income, a quant fund that had
once produced strong, long-term market
outperformance and then fell off the rails.
It was September 2011 when Vanguard
fired long-time manager Mellon Capital
Management (formerly Franklin Portfolio
Assoc.) and replaced them with a trio of
quantitative managers—D.E. Shaw, LA
Capital and Vanguard’s quant group.
The change to the portfolio was
immediate. As the chart on the left
shows, the number of stocks in the port-
folio almost quintupled in one month
and concentration in top holdings fell
from 28% to 20%. The portfolio has
doubled again, with more than 1,100
stocks at the end of August. Not surpris-
ingly, then, concentration has continued
to fall, and now is hovering around 16%
of assets in the top 10 holdings.
Performance has improved, though
the argument boils down to basis points.
You can see in the chart on the right that
Growth & Income’s relative outperfor-
mance is small. In the chart, the line
rises when Growth & Income (which
is benchmarked against the S&P 500
index) outperforms 500 Index. Over
the five years the new management triad
has been in place, the fund has only
outpaced 500 Index by about 5.5%. Its
five-year annualized return of 16.8% is
just 60 basis points better than the index
fund’s 16.2% return.
When I looked at performance on
a more granular level I found that on a
monthly basis Growth & Income beat
500 Index about 50% of the time, by
about 12 basis points on average. Still,
that’s enough to outpace the index fund,
which, when it outperforms, only gains
about eight basis points on the active
fund, on average. As I said, this is a
basis-point argument.
Many years ago, when Growth &
Income was in its index-beating heyday,
I used to recommend that investors only
use the fund in tax-deferred accounts,
because its after-tax returns weren’t able
to match the index fund’s returns.
That’s still the case. 500 Index has
a tax efficiency of a bit more than
97%, which means that after taxes on
distributions, shareholders keep about
97% of the fund’s returns. Growth &
MANAGEMENT
Growth & Income Is Back
More Stocks,
Less Concentration
Stocks in Portfolio
% in Top 10
8/068/078/088/098/108/118/128/138/148/158/16
# of Holdings
Concentration in Top 10
0
200
400
600
800
1000
1200
15%
18%
21%
24%
27%
30%
33%
Growth & Income Ekes Out
Superiority
9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15 3/16 9/16
Rising line = Growth & Income outperforms 500 Index
0.99
1.00
1.01
1.02
1.03
1.04
Income’s tax efficiency over the past
five years has run a bit under 88%. And
that makes a difference. In fact, over the
five years ending in the second quarter,
Growth & Income’s 4.2-percentage-
point advantage over 500 Index turned
into a 3.5-percentage-point deficit once
taxes were considered.
Investors in higher tax brackets
should absolutely choose 500 Index
over Growth & Income. Tax-exempt
investors can use Growth & Income as
a substitute for the index fund, and if
history is repeated, will earn a slightly
better return over long periods of time.
It’s your pick, and with five years
under their belts, I’m going to change
my rating on the fund from Sell to
Hold. It would be a Buy if it signifi-
cantly outperformed its benchmark, but
it doesn’t. n
saving name blind you to the other
options available at lower minimums.
U.S. Growth
Hold. Has U.S. Growth been reborn,
and is it worthy of your dollars? The
short answer is that it’s moving in the
right direction, but still hasn’t earned a
place in your (or my) portfolio.
It’s true that U.S. Growth has sta-
bilized. Since Vanguard finally fired
AllianceBernstein in the fall of 2010 and
replaced themwithDelaware Investments
(since rebranded as Jackson Square
Partners) and Wellington Management,
the fund’s 124.8% return through August
2016 compares favorably to Growth
Index’s 117.9% gain and isn’t far behind
PRIMECAP’s 127.0% advance.
But in February 2014, U.S. Growth
picked up two additional sub-advisers,
Baillie Gifford and Jennison, when
assets from the abysmal Growth Equity
were merged into the fund. As you can
see in the table on page 7, U.S. Growth
simply isn’t that different from the bulk
of Vanguard’s other large-cap growth
funds. It’s no longer the dog that it once
was, and hence Dan and I raised its rat-
ing to a Hold at the end of last year, but
under its plethora of managers, the fund
doesn’t stand out as a market-beater,
either. It’s a shame this fund can’t be
juiced up by trimming its management
structure, because Vanguard could use
a good, well-managed large-cap growth
fund that’s open to new shareholders.
As it stands, this one doesn’t fit that
bill. n
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