(PUB) Investing 2016

Value has been a long-term winner, but as we’ll see, may not be the ideal pick for the next 17 years. While I’m selling Selected Value from the Model Portfolios , I’m switching my rating on the fund to a Hold from a Buy in recog- nition of the fact that some of you will continue to hold onto it because of your long-term gains and, frankly, because the fund remains good enough that there may come a time when we want to purchase it again. When might that be?Well, one reason for Selected Value’s periodic underper- formance has been its managers’ avoid- ance of real estate investment trusts, or REITs. As I’ve shown you in the past, REITs have had a significant impact on the performance of the mid-cap value indexes. Their decline during the finan- cial crisis was one reason Selected Value did so well then, on a relative basis. Should interest rates begin rising sub- stantially and income proxies like REITs and utilities lose steam, we might see Selected Value surge ahead. Jeff and I will keep our eyes open for that. Buying Past Performance What’s fascinating about Vanguard’s muddling with management at Selected Value is that, on the surface, the addi- tion of managers like Donald Smith & Co. and Pzena Investment Management should have been a net positive to the fund, given the companies’ track records. Both firms’ mid-cap value strategies have outperformed Selected Value over their lifetimes. However, despite the fact that the two newest managers have strong long-term track

records, they haven’t had the right stuff since joining the Selected Value team. How do I know this? First off, Vanguard doesn’t break out individual managers’ performance, so you have to do some digging. But both Donald Smith and Pzena manage separate accounts in the mid-cap value style. While there may be some variation between what they do in their separate accounts and what they do for Selected Value, it can’t be vastly different. Vanguard wouldn’t hire an outside manager based on one strategy and then force them to alter it drastically. Yes, Vanguard will sometimes ask that portfolios be slimmed down to “best ideas” or that risk be toned down a notch, but essentially they hire managers to do what they have always done. I feel the comparisons are apt. Unfortunately, the historical outper- formance Vanguard might have thought it was buying just hasn’t presented itself in the favor of Selected Value’s shareholders. Since coming aboard Selected Value in May 2005, Donald Smith & Co.’s mid-cap value strategy has underper- formed Selected Value, which means Barrow and Giambrone have outper- formed. However, both underperformed MidCap Value Index . Pzena has only been on the fund for two years, but in that short time, while the Pzena mid-cap value strategy out- performed both Donald Smith & Co. (which lost money in an up market) and Selected Value, it still lagged the index fund. Take a look at the charts below. (Note all the charts are reset to start at

have been fixtures in the Model Portfolios for almost 17 years. It turns out those original purchases were darned good for us. From the first purchase in the Growth Model Portfolio through March 2016, Selected Value returned 332.5%, more than three times the return of 500 Index , which gained 108.6%. It was the fifth-best Vanguard fund, not counting sector funds, over that period. Selected Value also tripled the index fund’s return between the time we first put it into the Conservative Growth Model Portfolio and the end of March. In fact, only REIT Index outperformed over that period, so Selected Value was the single best-performing diversified stock fund in the Vanguard stable at the time. And that’s the rub—at the time. Since those first purchases, Vanguard has monkeyed around with Selected Value’s manager lineup, adding Donald Smith & Co. in May 2005 and Pzena Investment Management in March 2014, and they’ve also offered up more options in the mid-cap value space. While I’m a very patient investor, I think it’s time to move on—17 years is a long time, so you can’t say I’m mak- ing a rash decision. But Selected Value has lost its appeal. Of course, if you started follow- ing the newsletter after my initial rec- ommendation to buy Selected Value (as many of you have), your returns aren’t going to match the numbers I quote above—every investor’s experi- ence is going to be unique. I share those numbers to show that Selected >

Since the Financial Crisis the IndexWins

Selected Value Hasn’t Provided Good Value

Selected ValueWas Less Volatile

600

400

100 110 120

Selected Value (Barrow) MidCap Value Index Donald Smith MidCap Value Pzena MidCap Value

350

500

300

400

30 40 50 60 70 80 90

250

300

200

200

150

Selected Value (Barrow) MidCap Value Index Donald Smith MidCap Value Pzena MidCap Value

Selected Value (Barrow) MidCap Value Index Donald Smith MidCap Value Pzena MidCap Value

100

100

0

50

5/07

5/08

5/09

5/10

5/11

5/12

3/00

3/02

3/04

3/06

3/08

3/10

3/12

3/14

3/16

3/09

3/10

3/11

3/12

3/13

3/14

3/15

3/16

11/07

11/08

11/09

11/10

11/11

11/12

4 • Fund Family Shareholder Association

www.adviseronline.com