(PUB) Investing 2015

QUOTABLE Vanguard Doth Protest Too Much

add to and subtract from various asset classes without advance warning. During the days when Vanguard was running three Managed Payout funds, allocations to broad classes like U.S. stocks ranged from 25.1% to 50.7% of assets. Commodity exposure ran from 2.3% to 12.2%. REITs could be 4.9% of a portfolio or 10.6%. Today’s Managed Payout, the agglomeration of the assets in the prior three trial funds, has been in its current form for a bit more than a year, but allocations to intermediate-term investment-grade bonds went from 4.9% to zero as the fund grabbed hold of a larger allocation to U.S. Treasurys through Total Bond Market II (an institutional version of Total Bond Market ). U.S. stock expo- sure through Total Stock Market has ranged from a high of 25.7% to 20.9%, all over the course of a few months. Also, consider the shifting tides underneath other Vanguard funds-of- funds. While asset allocations tend to remain stable from one month to the When Vanguard was running three Managed Payout funds, allocations shifted regularly. next, Vanguard has made several course corrections to its own asset alloca- tion objectives in various funds, as the recent decision to go with a 40% allocation to foreign stocks and 30% to foreign bonds in its Target Retirement funds makes clear. Some unconstrained, flexible, go- anywhere income funds will of course falter, and their high expenses will be just one factor tripping them up. Others will not. It’s just like choosing a good stock fund: Watch the manager, and watch the fees. Vanguard should know better than to cast stones, however, when they also offer up some glass houses with less- than-transparent windows. n

LACKING A GO-ANYWHERE bond fund, Vanguard seems to be making it a priority to find fault with managers who run “unconstrained” or “flexible” income funds that invest in both gov- ernment and corporate bonds across a broad range of maturities and credit quality along with other more esoteric bonds from, say, emerging markets. The latest is a missive that attempts to enumerate the risks inherent in a fund that gives the manager leeway to

pick and choose allocations to various bond asset classes. But the line that got me was Vanguard’s observation that “investors lose control over their asset allocations” in such funds, and this means that the “underlying risk expo- sures can become difficult to identify in advance.” What’s funny is that this is pre- cisely what has been going on at the Managed Payout funds for years, as Vanguard’s management team chose to

QUOTABLE

Vanguard’s Call on U.S. Growth

“SO, WHAT DOES HE LIKE NOW?” asked Kiplinger’s 10 years ago of Joe Brennan, then a prin- cipal in Vanguard’s portfolio review group. Brennan’s reply: Large-cap growth, and in particular U.S. Growth and Growth Equity . Well, we all know what happened to Growth Equity. The fund cratered under the man- agement horrors of Turner Investment Partners, and after years of waiting for a turnaround, Vanguard finally gave up and folded its remaining assets into U.S. Growth last year, forever relegating Growth Equity’s performance history to the dustbin of time. But what of U.S. Growth over the period since Brennan was pounding the table for the fund over and over? (Yes, he continued to defend the fund’s horrible underperformance and its man- agers as questions continued to fly over why the fund was doing so poorly.) Well, between April 2005, when Brennan was recommending U.S. Growth, and the end of March 2015, a decade over which numerous managers have come and gone, the fund returned 132.3%, or 8.8% per annum, which is about 0.4% per annum ahead of Total Stock Market ’s 8.4% gain. That might be all fine and well, except that Growth Index , that plain-vanilla large- cap growth fund which hasn’t been burdened by a merry-go-round of managers, gained 142.3%, or 9.3% per annum over the same period. More to the point, if you were looking for excellent active management in the large-cap growth arena, it would have paid to have focused on either PRIMECAP or PRIMECAP Core , which gained 10.8% and 10.7%, or 178.4% and 176.0%, respectively, over the decade. Kiplinger’s wrote that it didn’t pay to bet against Brennan’s picks. “After all, who knows these managers better than he does?” I won’t bother answering that question, as the numbers tell the tale, but I will say that there’s an inherent problem in asking a Vanguard executive to recommend a Vanguard fund, because neither you nor I can know what internal bias, corporate bias or external factors are influencing the recommendations. For instance, was a recommendation to buy a chronic underachiever an attempt to staunch the flow of assets out of the portfolio? Or was it a means to deflect atten- tion from better-performing funds like PRIMECAP Core, which was then still open to new inves- tors but might have been attracting too many dollars despite its higher expenses, something that flies in the face of the indexing dogma that has driven Vanguard’s growth? As Vanguard heads further and further into the advice business, no matter how low their fees, it will pay to remember that not only is there no free lunch, but even a cheap one may cost you more than you know.

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