(PUB) Investing 2016

MULTIMANAGERS Vanguard Trims Its Ranks

much quicker, taking 22 months. Again, is the difference between a 50.3% loss and a 52.9% loss worthy of the claim that multimanagement reduces risk? One could counter that the index fund’s faster recovery more than outweighs the ben- efits of the slightly smaller decline. As for the final “benefit” of multi- management, the reduction of “manager risk,” well, that’s kind of obvious, isn’t it? If Vanguard doesn’t hire managers who all invest in the exact same stocks and in the same fashion, and they hire a bunch of them, then ipso facto , you can claim lower manager risk. But what’s the benefit? I should note that at the end of 2014 (the last year for which data is available), only two of Vanguard’s nine directors owned shares in Explorer, and only one, Bill McNabb, owned shares in Morgan Growth (and not too many, at that). So, Vanguard’s directors really don’t have a lot of skin in the game when it comes to these two multimanaged messes. Vanguard needs to do more to reduce the head-count on its multimanaged funds. Shareholders have mutinied, as neither fund has seen investor inflows in any of the last seven calendar years, a record only matched by Growth & Income , Windsor and Windsor II , all of which are domestic stock funds, open to new investors and multimanaged. I will give Vanguard credit for tacitly admitting they’ve gone overboard. On the Other Hand While Vanguard was cutting manag- ers at Explorer, in another announce- ment it added two portfolio manag- ers from Arrowpoint Partners to Small Company Growth Annuity . This small-cap growth annuity is only run by a fraction of Explorer’s managers and has outperformed the more man- ager-laden fund, which to me is further evidence that adding managers doesn’t improve performance. We’ll have to see if the addition of Arrowpoint sharpens the annuity’s returns, or dulls them. n

HAS VANGUARD FINALLY figured out what I’ve been saying for years, that too many cooks spoil the multimanaged fund broth? In early January, Vanguard reduced the headcount on both Explorer and Morgan Growth , two of the poster-children for excessive multimanagement. This is good news for the funds’ shareholders. But I don’t think they went far enough. Vanguard continues to claim that throw- ing lots of different management teams at a single portfolio is smart active manage- ment, but I beg to differ. In the latest manager musical chairs, Century Capital Management was fired from Explorer and leaves the Vanguard fold, while Kalmar remains a manager on Explorer but has been relieved of its role on Morgan Growth. This reduced the headcount on Explorer to seven management teams made up of 15 individual portfolio man- agers, while Morgan Growth will now be served by four teams totaling eight portfolio managers. Vanguard says that the multimanager format, which it first adopted in 1987, “can reduce portfolio volatility, provide potential for long-term outperformance, and mitigate manager risk.” I’d say they are batting, at best, one out of three. Let’s take performance.Two charts tell the tale here. The first shows Explorer’s relative performance against its Russell 2500 Growth index benchmark. The persistent downtrend confirms what I’ve been saying for some time. You can pretty much say the same thing for Morgan Growth. While its performance lately has mimicked the Russell 3000 Growth index, that’s little comfort for its shareholders. You can see that as Vanguard kept adding manag- ers, performance suffered. Why bother investing here? As for multiple managers reducing risk, Vanguard might want to talk about betas and standard deviations and all that market mathematics, but I think

Explorer vs. Russell 2500 Growth Index

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Rising line = Explorer outperforming

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Morgan’s Many Managers

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Rising line = Morgan outperforming Russell 3000 Growth Idx.

Jennison hired as fourth team

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Roll & Ross fired, replaced by Vanguard internal ▼

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▼ Husic added as fourth manager

▼ Kalmar and Frontier

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replace Franklin. Morgan now has five management teams.

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multimanagers, Franklin and Roll & Ross, added

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we should use a simple metric, one that really relates to shareholder experience: Maximum Cumulative Loss (MCL), or drawdown. During the 2008–2009 financial cri- sis, Explorer investors suffered a 52.4% loss over 16 months ending in February 2009. It took 24 months for the fund’s managers to recover that loss. SmallCap Growth Index suffered a 53.5% loss over the same period and took 22 months to recover. Is the difference between a 52.4% loss and a 53.5% loss really risk management? And given the fact that the index fund recovered faster, I’d say that, at best, the two funds came to a draw. As for Morgan Growth, the fund’s shareholders lost 50.3% during the finan- cial crisis over 16 months. That loss was recovered in 37 months. Extended Market Index investors lost a bit more, 52.9% over 21 months, but recovered

The Independent Adviser for Vanguard Investors • February 2016 • 7

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