(PUB) Investing 2015

dollar in the fund. As for Vanguard’s directors, Chairman Bill McNabb is the first to have put money here—and he only added an account in 2014. His stake: Somewhere between $10,001 and $50,000—a pittance, by his stan- dards, as he generally has more than $100,000 in the funds he owns. Morgan Growth is no “select” fund, in my book. Vanguard’s best growth funds, run by the PRIMECAP Management team, are, as you know, closed to most new investors. But that doesn’t mean you should then recom- mend a has-been. Morgan Growth was once a good fund. It isn’t any longer. SmallCap Index Rounding out the index fund offerings in all capitalization levels, SmallCap Index is an obvious filler for the Select Funds , since it can be used with MidCap Index and 500 Index to tilt allocations across the market spec- trum if you aren’t simply going to buy Total Stock Market. SmallCap Index began life as an actively managed fund, but was turned into an index fund in 1989, tracking the Russell 2000 Index. It later transitioned to the MSCI SmallCap 1750 Index in 2003, and then again to the CRSP U.S. Small Cap Index in 2013. Many of Vanguard’s directors own shares in this fund, though at last report manager Michael Buek did not. Again, the question is whether you are going to be an indexing purist and simply buy Total Stock Market for your domestic stock exposure, or mix and match among the various index offer- ings that Vanguard has “selected.” Strategic Equity This Vanguard-run quant fund is not currently listed as a Select Fund (though Vanguard says it reserves the right to change its Select Fund lineup), but it’s a common component of portfo- lios built by Vanguard’s asset manage- ment group for clients paying fees for portfolio management. That’s why I’ve included it. Since this is pure Vanguard— designed byVanguard, run byVanguard, and recommended by Vanguard—let’s

take a look at whether Vanguard is eat- ing its own cooking. First off, not one of the three managers responsible for this fund (and the computers that drive it) owns shares. Nor do any of Vanguard’s directors, except Mark Loughridge, who made his first purchase just last year. So, when Vanguard recommends this fund to fee-paying clients, those clients aren’t eating from the same table that’s feeding most of those responsible for the fund’s performance. Now, on to the fund. When intro- ducing the fund almost 20 years ago, Vanguard’s founder Jack Bogle said Strategic Equity (which was originally dubbed Horizon Aggressive Growth) would be a “Fidelity killer,” mean- ing it was going to run performance circles around the growth managers at its Boston rival. It didn’t exactly work out that way, however. The fund could be called a SMID, or small-cap/mid-cap, fund. It’s had a cou- ple of benchmarks over the years, but you’d probably want to compare this to Extended Market Index , which is the small-cap/mid-cap complement to 500 Index that’s been around since 1987. And on that score, Strategic Equity has run both hot and cold. You can see in the top left chart on the next page that Strategic Equity has had some bouts of terrific relative performance against Extended Market Index and some weak periods, as well. Yes, the fund has outperformed by almost 30% overall. A dollar invested in Strategic Equity at inception would have grown to about $8.19 by the end of May 2015. That same dol- lar in Extended Market Index grew to $6.37. That’s not bad, but the ride was anything but smooth, and inves- tors would have to have had stomachs of steel when the fund churned out a 59.0% decline during the financial cri- sis. Extended Market Index, by com- parison, lost 52.9% during the same period, but took less than half as long as Strategic Equity to recover that loss. That’s probably one reason the fund didn’t grow at all for about four years, despite putting up decent returns. Only as Vanguard has begun putting the fund into client accounts, and investors >

I think is often overlooked by ana- lysts on Wall Street, whose focus is on large companies that can generate the biggest investment banking fees. Research, therefore, lags. Second, good mid-cap companies tend to be pretty good growers. Vanguard doesn’t have many good actively managed mid-cap funds. Capital Opportunity used to inhabit the space, but is now too big, and closed. Selected Value is a good value-oriented mid-capper, but as it now has a third management team, I’m becoming wary of it losing its edge. And MidCap Growth has never prov- en to be a winner. That’s one reason you’ll find mid-cap index funds in the Model Portfolios . This is a good choice as a Select Fund, but I’d bet it gets lost in the sauce, surrounded as it is by bigger-cap index fare. Morgan Growth If Explorer is the poster child for Vanguard’s penchant for larding up funds with too many managers, Morgan Growth comes in a close sec- ond, with five management teams and 10 named portfolio managers mucking up the works. Even Jack Bogle has complained about the fund’s manage- ment obesity problem. This is one of those go-anywhere growth funds that seems to have gone everywhere, and nowhere. Since the November 1997 inception of Growth Index , which one could have bought in lieu of this growth fund, Morgan Growth’s average annualized five-year return of 8.2% is a bit under the aver- age 8.4% five-year return for the index fund. Its average three-year return of 9.5% lags the index fund’s 9.9% annu- alized three-year average. And over the past decade, for every dollar invested in Morgan Growth, which turned into $2.31, that same dollar in Growth Index grew to $2.40. As for managers aligning interests with shareholders, Paul Marrkand at Wellington is the only portfolio manag- er on the fund with any money invested here—he’s got more than a million dol- lars in Morgan Growth. As for the other nine managers, not a single one has a

The Independent Adviser for Vanguard Investors • June 2015 • 13

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