(PUB) Investing 2016

short, Dan and I see more oppor- tunity than danger in the high-yield bond space. Conservative Allocation Annuity Hold. Introduced in 2011, Conservative Allocation Annuity is an all-index fund-of-funds targeting a 40% stock, 60% bond allocation. The 60% allocation to bonds is split between Total Bond Market Annuity and Total International Bond Index . Interestingly, unlike nearly every other portfolio where Vanguard blends togeth- er domestic and foreign bond index holdings, only 20%, not 30%, of the bond allocation is going toward over- seas bonds. Filling out the stock portion, Equity Index Annuity receives 23% of assets, Total International Stock Index gets 12% and a bit more than 5% goes to Extended Market Index . This is one of three options for those who want to access the “Guaranteed Lifetime Withdrawal Benefit” rider. That may be attractive to some, but, as discussed earlier, it comes at a high cost. I think investors can do better fol- lowing one of the Model Portfolios or building their own conservative annu- ity portfolio using some of the active- management jockeys available here. Moderate Allocation Annuity , which turns five in October, is an all-index fund-of-funds target- ing a 60% stock, 40% bond alloca- tion. Like its more conservative sibling, the 40% allocation to bonds is split between Total Bond Market Annuity and Total International Bond Index, but the foreign bond portion only accounts for 20% of the bond sleeve. Filling out the stock portion, Equity Index Annuity receives 34% of assets, Total International Stock Index gets 18%, and 8% goes to Extended Market Index. The reason to invest here would be to access the “Guaranteed Lifetime Withdrawal Benefit” rider. Again, I think investors can do better following the Model Portfolios , or, heck, the next annuity, which is a better alternative for an investor looking for a stock-tilted balanced portfolio. > Moderate Allocation Annuity Hold.

Balanced Annuity: Active Beats Passive

Jim Barrow Solo vs. Windsor II

0.96 0.98 1.00 1.02 1.04 1.06 1.08 1.10 1.12

1.20

Rising line = Div. Value Annuity beats Windsor II

Rising line = Balanced Annuity outperforms Moderate Allocation Annuity

Armstrong Shaw hired at Windsor II

1.15

Sanders Capital hired at Windsor II

1.10

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▼

1.05

Lazard hired, Equinox and Tukman both fired at Windsor II ▼

▼ Armstrong Shaw fired

1.00

▼ Hotchkis

at Windsor II

and Wiley hired at Windsor II

0.95

Firm hired Firm fired

0.90

0.85

6/12

6/13

6/14

6/15

12/11

12/12

12/13

12/14

12/15

12/00

12/01

12/02

12/03

12/04

12/05

12/06

12/07

12/08

12/09

12/10

12/11

12/12

12/13

12/14

12/15

As I mentioned, Windsor II and Diversified Value Annuity differ in their level of concentration. Where Vanguard has hired five different firms (including Barrow Hanley) to manage pieces of Windsor II, Barrow Hanley is the only firm calling the shots at Diversified Value Annuity. And despite its higher expenses, Diversified Value Annuity has outpaced Windsor II, no matter how many managers Vanguard added to make the older fund “better.” I expect Fahrenbruch and Ganucheau to continue practicing Barrow’s approach of holding around 45 stocks with roughly one-third of assets in the top-10 picks while keeping trading to a minimum. Though managed in the Windsor II style, focusing on large-cap value stocks, this annuity can be used as an imperfect substitute for Selected Value in my Model Portfolios . Equity Income Annuity Buy. Though it wasn’t always the case, this fund has been a clone of Equity Income for over a decade. At first, original Equity Income manager Newell Associates ran the annuity solo. But in August 2003, Newell was fired and replaced byWellingtonManagement and Vanguard’s in-house equity group. It took several years for the two funds to draw closer, but they have been essen- tially the same for the past decade, with the annuity lagging under the weight of higher overall expenses. In the past, I preferred the stock-pick- ing skills of Jim Barrow at Diversified Value Annuity. I still lean that way, but with Barrow gone, I’m watching

Balanced Annuity Buy. This is a Wellington clone, with about two-thirds of its assets in divi- dend-paying, large-capitalization stocks and the remainder in intermediate-term bonds. If you’re looking for a straight balanced fund, look no further. As you can see in the first chart above, since the index-based Moderate Allocation Annuity’s inception, Balanced Annuity has consistently outpaced its younger sibling. And I thought active manage- ment didn’t work? Capital Growth Annuity Buy. With PRIMECAP Management running this portfolio unfettered, this is by far the best of Vanguard’s annu- ity options. Capital Growth Annuity used to be what I called a fraternal twin to PRIMECAP . It now moves almost like a clone. What I can’t get my head around is why this fund remains the fifth smallest annuity in terms of assets— over the past 10 years it has been the best performing annuity, gaining 8.6% a year. The next closest? Equity Income with a 7.4% annual return. If I owned an annu- ity (and I don’t), I’d consider putting all my money here. Diversified Value Annuity Buy. This is the concentrated version of Windsor II . And as with Windsor II, longtime manager Jim Barrow of Barrow Hanley stepped away from the portfolio at the end of the year, handing the reins over to his two handpicked successors: Jeff Fahrenbruch and David Ganucheau. Only time will tell if they are able to fill Barrow’s shoes.

14 • Fund Family Shareholder Association

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