(PUB) Investing 2015

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Model Portfolios Over Two Decades and Counting 5-year 10-year

over time. But to paraphrase Livermore, it wasn’t my trading that created the long-term track record you see, but my buying and sitting, with top-notch managers doing the heavy lifting. In words longtime FFSA members will surely be familiar with, I believe in buying the manager, not the fund. This isn’t to say I don’t make trades in the portfolios (I have), or that I won’t in the future (I will), but it isn’t trading that’s carried the day. Another way to think of sitting rath- er than trading is to go with a base- ball metaphor. Rather than swinging at every ball that comes across the plate, I wait for the right pitch. Warren Buffett has described investing as playing base- ball without a called strike. In his anal- ogy, stock prices are like pitches, and you can let them pass you by all day, every day without being called out— you can wait for your perfect pitch. While Buffett was talking about indi- vidual stocks and individual companies, you can certainly apply the lesson to investing with mutual fund managers. No one says you have to buy every manager out there, and you certainly wouldn’t want to. You and I can be selective and wait for the right manager to come along before investing. (Vanguard seems to take a different tack, putting more and more managers onto many of its funds, diluting the best ideas with globs of bad ones and, for the most part, striking out. Maybe the firm should think about sit- ting still and taking fewer swings.) Partnering with a few select manag- ers and then having the discipline to sit on our hands and spend time in the markets has been a successful strategy for you and me in the long run. It is a formula I’ll continue to follow. Before delving into those managers and funds that I expect will continue to deliver for all of us, let me say right up front that many of the funds in the Models (as well as the alternatives that I’ll mention below) make up the bulk of my investable net worth—I defi- nitely eat my own cooking. Jeff is also invested in these funds and with these managers. He eats the cooking as well.

20-year Since Inception

91.7% (13.9%)

130.5% (8.7%) 893.6% (12.2%) 1,479.8% (12.2%)

Growth Model

85.3% (13.1%) 117.02% (8.1%) 601.7% (10.2%) 993.2% (10.5%)

Conservative Growth Model

71.6% (11.4%) 96.7% (14.5%) 103.6% (15.3%) 23.1% (4.2%)

93.6% (6.8%) 126.9% (8.5%) 107.1% (7.6%) 56.4% (4.6%)

451.5% (8.9%)

684.4% (9.0%)

Income Model

— 556.0% (9.9%)

Growth Index Model*

543.1% (9.8%) 899.7% (10.1%)

500 Index

Total Bond Market 321.8% (6.2%) Note: Table shows cumulative and annualized (in parentheses) total returns over the periods listed through 12/31/14. I’ve compared returns to 500 Index rather than Total Stock Market since the latter did not exist at the time of the Models ’ 1991 inception. * Model inception 3/95. 220.0% (6.0%)

mediocre and great alike—underper- form at some point. Fortunately, the PRIMECAP team’s periods of outperfor- mance have more than made up for the inevitable periods of underperformance. The PRIMECAP team practices growth-at-a-reasonable-price, or GARP, investing. The managers search for tri- ple-play companies that can grow earn- ings at a better-than-market rate, can be more profitable, and can be purchased at the right price. Unlike most growth managers, they refuse to pay high prices for those companies’ stocks. So they wait. Also unlike other growth managers who constantly turn over their portfolios looking for growth, the PRIMECAP team is patient, often holding stocks for years and years. The team is fairly unique, as each manager takes a slice of the portfolio and invests as he sees fit. Though there is no collaboration on holdings, per se, several managers may find value in the same stocks. The resulting portfolio often looks nothing like the broad stock market. Capital Opportunity typically holds 130 stocks or so, with the top 10 positions soaking up about a third of assets. Health care and technology play a big role—combined, the two sectors account for two-thirds of the portfo- lio. Clearly the PRIMECAP managers invest with conviction. My only real disappointment with Capital Opportunity is that it has out- grown its original objective. What was once a standout fund investing in small to mid-sized companies is now a solid fund investing in mid-sized and large companies. I have long advocated that inves- tors switch to the private-label Odyssey funds. However, PRIMECAP Odyssey Aggressive Growth (POAGX)—the

And we are quite satisfied with the meals we’ve prepared. Additionally, I should note that ever since this newsletter’s first issue in January 1991, I’ve kept my Model picks focused exclusively on Vanguard’s funds. While I’ve offered alternatives, the Models remain Vanguard-only. And when a fund has closed, I’ve kept it in the Models that already owned it, but haven’t added it to any of the others if you, the Vanguard investor, couldn’t fol- low that lead. Yes, I would prefer to put the PRIMECAP Odyssey funds into my Models , but I haven’t, because I know many of you want all Vanguard, all the time. So be it. Let’s go over the funds and managers that make up the Models . Capital Opportunity The last time I wrote a Model Portfolio Funds Focus in October 2012, Capital Opportunity was com- ing off a tough stretch, returning 8.4% a year over the prior three years, lag- ging behind 500 Index ’s 13.1% annual return. My advice at the time: “I do not believe the PRIMECAP Management team has lost its mojo…If you already own Capital Opportunity and your port- folio is underweight large-cap growth stocks, I’d look to add to this position, knowing that the PRIMECAP team has consistently followed periods of under- performance with periods of strong outperformance.” Well, I hope you followed that advice, as Capital Opportunity returned 78.3% versus 500 Index’s gain of 49.9% from the end of September 2012 through the end of 2014. The PRIMECAP Management team is among the best in the business—not just in Vanguard’s stable. As I’ve dis- cussed in the past, all managers—lousy,

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