(PUB) Investing 2015

DATA MINING When Vanguard Fudges on Performance

Vanguard is famous, the headwind for non-Vanguard peers puts these manag- ers at a disadvantage from the get-go. If Vanguard picks good managers (and sometimes it does) then beating peers is nice, but it’s not the metric share- holders should be concerned with—it’s benchmarks. If a fund can’t beat its benchmark, then why invest in it? Buy the benchmark in the form of an index fund or ETF. I took the helm and did a little navigating through the data myself. You can take a look at the table on page 7. In it, I’ve listed the 10-year perfor- mance not just through September, but also through December. Why? Well, I couldn’t understand why a story that was being published in late January or early February wouldn’t bring the data up to the most recent quarter. What you’ll see when you compare

ten-year track record outpaced the aver- age annual return of their peer groups over the decade ended September 30.” First off, this is hogwash. Try as I might, I couldn’t find 18 multi-man- ager funds (equity or not) with 10-year records. Why? Because there aren’t 18. There are 18 multi-manager funds (17 are equity funds and one is a bond fund), but only eight have been multi- managed for the past decade. Vanguard acknowledged that I was correct, and a week or so later replaced the offending article with a corrected one. But second, and more importantly, Vanguard’s use of peer groups as a metric for comparison is simply dis- ingenuous, particularly in the age of indexing and ETFs. It’s a given, at least in my book, that with the super- low operating expenses for which

I’VE LONG UNDERSTOOD why Vanguard adds manager after manager to many of its funds. It doesn’t want to shut the funds down as cash flows in, and it likes the idea that as the funds’ portfolios grow in size, they become more index-like, which means they’ll never fall too far down in the rankings. Explorer and Morgan Growth are the poster children for this “strategy.” What I don’t understand is why Vanguard insists on fudging the data to make a point (one which is invalid in my opinion) that funds run by lots and lots of different portfolio management teams are strong performers. They aren’t. Vanguard’s newsletter, In The Vanguard , had the latest example, with an article titled “For active stock funds, many heads can be better than one,” which claims, “All 18 of our multi- manager equity funds with a minimum

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The largest position is just over 4%, which is a U.S. stock, Royal Caribbean. The next largest is 3.5%. We have the ability to run the larg- est positions up to around 6%, but we’ve never gotten there. And Royal Caribbean is only as large as 4% because the stock rose 75% last year. It was one of our most successful investments and we just let it run. How big is the “incubator” in your portfolio? About 40 stocks make up 20% of the portfolio. Typically these are our higher risk, higher reward stocks where the future does have uncertainty, and they could go very right, or they could go very wrong. But we think you make a lot more money if they go right than you lose if they go wrong—asymmetric returns. You could make 300% return or you could lose 70% of your initial investment, but that is very attractive odds in a portfolio context. How do you decide when a company is just suffering a tempo- rary setback rather than a permanent change in fortune? That’s one of the most difficult things to do. You have to do it by looking at each company afresh on a regular basis—not too frequently, but certainly an annual basis and saying, “From here, do we still expect that above-average growth?” Last year, we reviewed the upside for just about every stock in the portfolio over a succession of meetings with a number of colleagues, and those that didn’t meet [our] hurdle typically have been sold or are in the process of being sold. We don’t hold onto things out of loyalty. We hold onto them because we think we are going to make money. The danger is that if we have held something for 10 years and have

a cozy relationship with the [company], we might be a little bit slow to react to a deterioration in management or strategy or market position. But being slow to react is often the right thing to do. We think you make more mistakes by being too quick to react. Let’s talk about Europe for a bit. Many of the companies you own in Europe don’t rely on local economies for the bulk of demand. But do investors view them with an eye to European trade anyway? We have very, very few European-listed companies that are exposed to European demand. Most are exporting from Europe or are global com- panies that just happen to be headquartered there. In fact, we are beginning to wonder now, six years into an economic downturn, after the European banks have been recapitalized a number of times, after all the efforts that governments have made, whether there may be signs of things getting better at a domestic level, and whether we should actually try and consciously find some exposures to an improved European economy. Within Europe, not only are we not exposed to domestic Europe, we are also not very exposed to the euro zone. Most of our European exposure is to companies based in Scandinavia or in Switzerland, which are not part of the euro. But again, if the euro is going to be a weak currency, that is going to help euro- based exporters, and it may be that there are some euro-based compa- nies that we should be adding to the portfolio. In terms of Greece and the “Grexit,” as they call it here, I think it is an irrelevance. It may happen and it may not happen. I don’t think the Greeks are helping themselves at all. We have no exposure to the Greek stock market. If anything, it would probably be helpful to the euro to

6 • Fund Family Shareholder Association

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