697 / 708
The Independent Adviser for Vanguard Investors
•
November 2016
•
7
FOR CUSTOMER SERVICE, PLEASE CALL
800-211-7641
inception. The latest change came in
July, when Peter Higgins was dropped
from the fund, leaving his Wellington
Management colleague David Palmer
as the sole manager.
Palmer was originally added to
Capital Value in December 2009 to
tone down the high-octane opportunistic
strategy that Higgins practiced. It is not
clear how successful Palmer was in that
effort, and under the dual management
structure, Capital Value returned 70.8%
while Total Stock Market advanced
114.1%.
But since going solo, Palmer has
wasted no time in making Capital
Value’s portfolio his own. In the first
month after Higgins’ departure, the
number of stocks went from 153 down
to 88, the percentage of assets in the
top-10 holdings increased from 20%
to 26%, and the median company size
increased from under $12 billion to
over $26 billion. The first month also
saw dramatic changes in sector weights,
as financial stocks jumped from 21%
of the portfolio to 28% (though, in
September, Palmer cut financial stocks
back down to 22% of the portfolio), and
technology stocks were cut from 17%
to 11% of assets.
Given the lack of single-manager
funds at Vanguard, Capital Value is
one to keep an eye on, but it is not
entirely clear how the fund will per-
form with Palmer steering the ship
on his own. Since recommending that
investors with a penchant for trading
buy the fund at the end of September
2015, Capital Value has rung up a
8.9% return, lagging Total Stock
Market Index’s 12.3% return. Dan and
I are reassessing our three-year trading
strategy for Capital Value given the
potential for lower volatility, if that’s
what truly happens. But for now we’re
sticking with it, and suggest you do
as well. Our continuing “Buy” on the
fund reflects that thinking.
MidCap Growth
Sell.
MidCap Growth
was over-
hauled a decade ago when the fund’s
original manager was shown the exit.
As Dan and I discussed in the August
newsletter, Vanguard talks about the
fund’s track record as if this complete
management change didn’t take place.
Don’t be fooled. The relevant track
record starts in mid-2006 when the
two replacement managers, Chartwell
Investment Partners and William Blair
& Co., got up to speed.
Since MidCap Growth Index’s incep-
tion (just a couple months after MidCap
Growth came under new management),
MidCap Growth has gained 117.0%,
while the index fund has gained 108.6%.
Sounds good, right? Unfortunately, if it
weren’t for about 20 weeks from late
June 2008 through late November 2008,
when this fund went on a short-lived tear
(based, I believe, on a few great stock
picks), the story of their relative perfor-
mance would be reversed.
Or consider that the S&P MidCap
400 Growth index (not the fund, which
launched in 2010) gained 150.9% since
MidCap Growth Index’s inception—
merely changing the benchmark alters
the story. You also would’ve been better
off owning any one of the PRIMECAP-
run funds.
Since the reboot, the active fund has
outperformed when markets stumbled
(such as 2008 and 2011), and lagged
when markets rallied. That may appeal
to some, but one great 20-week peri-
od out of a decade-long track record
doesn’t convince me this fund is mate-
rially better than the index or worthy of
our investment dollars.
Selected Value
Hold.
Once a standout—if unrecog-
nized—fund, Vanguard watered down
Selected Value with too many manage-
ment teams.
Primary managers Jim Barrow
and Mark Giambrone are quintessen-
tial value investors looking for stocks
whose prices relative to earnings or
book-value are below the market’s mul-
tiples while generating a decent dividend
yield. Dividends afford Barrow and
Giambrone patience—they are essen-
tially being paid to wait for the market
to recognize the value of their holdings.
A decade ago, Donald Smith, of
Donald Smith & Co., was added to the
mix to handle about one-quarter of the
fund’s assets. Smith practices a some-
what riskier style, searching for deeper
“value” than Barrow. Under Barrow
and Giambrone’s solo tasking, Selected
Value ran with about 40 stocks and a
third of assets going to the top-10 hold-
ings. With Smith on board, the portfolio
consistently held 60 to 70 stocks, with
about 25% of assets in the top holdings.
Then, in March 2014, Vanguard hired
a third sub-adviser, Pzena Investment
Management. Pzena also manages piec-
es of
Windsor
and
Emerging Markets
Select Stock
, in addition to the overseas
U.S. Fundamental Value
for Vanguard.
The firm has quickly become respon-
sible for about 15% of the fund—
largely at the expense of Barrow and
Giambrone’s allocation. Since Pzena
joined, the number of holdings has
drifted up to 120 or so.
While it’s hard to assess who is
impacting performance, since Pzena
joined Selected Value, the fund’s 5.6%
gain has trailed MidCap Value Index’s
15.6% return and S&P MidCap 400
Value ETF’s 13.1% advance. In the
past, Selected Value has held up rela-
tively well in down markets, but given
Pzena’s track record of focusing on
financial stocks, which generated large
losses in the credit crisis, it is not clear
that Selected Value will be as defensive
as it once was.
This is a situation where I would’ve
liked to have seen Vanguard close the
doors rather than adding managers.
Strategic Equity
Hold.
Like Capital Opportunity and
MidCap Growth, I discussed
Strategic
Equity
in the aggressive growth fund
roundup, but it too falls into the mid-cap
space. Vanguard’s Quantitative Equity
Group runs this computer-driven fund,
meaning the managers program the
computers and the computers do the
stock picking. While there have been
stretches when the computers picked
stocks well, there’ve also been runs
when they haven’t. The bottom line is
that you would’ve been better off just
owning MidCap Index and not worry-
ing about Vanguard’s programming. Of
course, you know that I think you can
do even better partnering with the stock
pickers at PRIMECAP Management.
n