(PUB) Investing 2015

many adherents—even at Vanguard. Consider that Vanguard has often handed assets over to quantitative man- agers who, in part, rely on past per- formance to choose stocks for their portfolios. To name a few, just look at the momentum strategies employed by Acadian Asset Management ( Global Equity ) or Vanguard’s Equity Investment Group ( Strategic Equity , Strategic SmallCap Equity , U.S. Value and various other sub-portfolios) or the managers at Growth & Income . As I’ve said, the Hot Hands approach doesn’t work each and every year, and some “persistence of performance” investors have had their heads handed to them over the years chasing the strategy. One fund guru who used to pursue the “persistence” theory gave it up because it didn’t work within the huge sea of funds that he was track- ing, then came back to it when results turned around. But after 2007, 2008 and 2009, he began to question whether the theory still held true. It failed to beat the market in 2010, and as far as I can tell, the strategy has been abandoned completely. However, I should note that this per- sistence tracker set himself up against a rather easy benchmark: The average equity fund. I consider the average fund a low hurdle that doesn’t hold a candle to the market benchmark I use. My Hot Hands is better, and 2014 notwithstanding, it works. Why It Works One of the reasons why Hot Hands works over the long run at Vanguard and not within the greater universe of funds is that Vanguard’s fund objectives and investment policies are very well- defined. With Vanguard’s funds, there’s little room for managers to change their tactics. (Though as we’ve seen time and time again, there is room for managers to change.) The managers do what they do, and they keep doing it, no matter how the markets move around them. If they don’t, then generally Vanguard fires them. One thing Vanguard wants is managers who strictly follow their investment styles and objectives. So using the prior year’s perfor- >

Long-Term Performance Hot Hands fund

Total return

Following year

Total Stock Market*

21.7% 18.2% -3.3% 28.0% 56.7% 12.5% 18.8% 15.0% 4.6% 46.8% 13.0% 13.5% 0.8% 35.5% 24.2% 22.0% 25.4% 28.8% 18.0% 13.7% -9.8% 44.5% 31.8% 20.5% 30.3% 5.2% -47.9% 21.7% 20.2% -1.6% 13.5% 43.9% 3.9%

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Windsor

16.8% 46.4% 43.0% 19.4% 57.0% 56.7% 24.0% 28.7% 37.7% 4.6% 55.9% 19.0% 44.7% 11.4% 38.8% 26.4% 36.8% 42.2% 97.8% 21.9% 15.0% -5.6% 57.4% 31.8% 20.5% 30.3% 22.5% -25.6% 81.5% 30.7% 10.6% 22.3% 44.4% 19.3%

18.7% 23.5% 3.0% 32.6% 16.1% 2.3% 17.9% 29.2% -6.2% 34.2% 9.0% 10.6% -0.2% 35.8% 21.0% 31.0% 23.3% 23.8% -10.6% -11.0% -21.0% 31.4% 12.5% 6.0% 15.5% 5.5% -37.0% 28.7% 17.1% 1.0% 16.3% 33.3% 12.4%

SmallCap Index

International Growth

Windsor

International Growth International Growth International Value

Windsor

U.S. Growth U.S. Growth

Explorer

Convertible Securities International Growth

PRIMECAP Windsor II Windsor PRIMECAP

Growth Index

Capital Opportunity SmallCap Value Index

Selected Value Global Equity

International Explorer International Explorer International Explorer International Explorer Growth Equity Dividend Growth Capital Value Equity Income Capital Value SmallCap Growth Index

Explorer

PRIMECAP Core — *Figures for Total Stock Market prior to inception are for the Wilshire 5000 index. Bold figures indicate superior performance in the given year. —

have updated my research as new funds have been introduced. I have looked at the best and worst Vanguard equity funds for each year between 1981 and 2014. The funds I exclude are sector funds, such as Energy , Precious Metals & Mining , Health Care , both of the REIT funds and the old Utilities Income (now Dividend Growth, which I do include), as well as the regional international index funds, Emerging Markets Stock Index , European Index and Pacific Index , since they are what I would con- sider sector funds. I’ve also excluded the actively managed Emerging Markets Select Stock . Plus, I don’t consider bal- anced funds and Market Neutral , which besides having a prohibitive investment minimum is really a hybrid fund. However, I do include the diversi- fied internationals in the mix. You see, domestic funds have the right to invest overseas, and, indeed, funds like U.S. Growth or PRIMECAP can and have

mance as a guide for selectingVanguard stock funds is not only useful, but very profitable, because investment styles and markets don’t automatically shift once the calendar turns from December to January. And ignoring hot strate- gies, or going with the “dogs,” as some investment advisers who use a “contrar- ian” approach like to suggest, can lead Vanguard investors to market-lagging and even negative returns. Dogs are dogs for a reason. They make great pets, but lousy bets. (Again, unless there’s a manager change for the bet- ter, or, as has been the case for a few years, a great fund and manager like Don Kilbride and Dividend Growth are simply are out of favor for a cycle.) But, let’s get back to the Hot Hands winners. Here are the ground rules for the strategy as I originally set them out in 1995, when I conducted the first analy- sis (and when we owned PRIMECAP , 1994’s best fund, inour Model Portfolios ). I’ve continued to follow these rules and

14 • Fund Family Shareholder Association

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