(PUB) Investing 2016

Vanguard’sMid-Cap Value Options

S&PNarrowly Outpaced CRSP

Different Indexes, Similar Risks

600

0%

400

Selected Value (since Barrow) MidCap Value Index Strategic Equity Capital Value S&P MidCap 400 Value ETF

S&P MidCap 400 Value ETF CRSP US Mid Cap Value Index

-10%

350

500

-20%

300

400

-30%

250

-40%

300

200

-50%

150

200

-60%

100

100

-70%

50

S&P MidCap 400 Value ETF CRSP US Mid Cap Value Index

-80%

0

0

3/02

3/04

3/06

3/08

3/10

3/12

3/14

3/16

3/00

3/02

3/04

3/06

3/08

3/10

3/12

3/14

3/16

3/02

3/04

3/06

3/08

3/10

3/12

3/14

3/16

Barrow and Giambrone were clearly the winners during the crisis. But that may not be good enough. Markets rise more often than they fall. In a crisis, yes, I’d prefer to have my money managed by Barrow and Giambrone. But markets run through cycles, and the bottom line is that Selected Value has not given us good value in the mid-cap value arena over a full cycle. While it protected us a bit during the financial crisis, over a full market cycle (or sev- eral), it’s underperformed, and there’s absolutely no reason to believe that the additional managers make it any better, as you can see in the table below. Reviewing the Options Now, you might think that it’s a pretty simple decision to sell Selected Value and buy MidCap Value Index. But as I mentioned, Vanguard has pro- vided lots of alternatives since we first bought Selected Value in mid-1999. Jeff and I cranked up our spreadsheets and looked at risks and returns for a few alternatives, including Capital Value , MidCap Value Index, S&P MidCap 400 Value ETF and Strategic Equity . The bottom line is that the active mid- cap value funds that Vanguard offers as alternatives just don’t cut it when it

comes to long-term performance, as shown in the left-most chart at the top of this page. Yes, Strategic Equity has had some shining moments, but it also has some significant downside risks. And, as you know, Jeff and I have found that trading into Capital Value when it’s down and selling it when it’s up can offer some potential for good gains. But for a long-term holding, it really comes down to the two index alternatives. So we went back and gathered data on the two indexes these options track, the CRSP U.S. Mid-Cap Value Index and the S&P Mid-Cap 400 Value Index, and made some comparisons. We came down on the side of the S&P option, though to be honest, there are rea- sons you could choose the CRSP option as well. For instance, we can only access the S&P index through an ETF, while the CRSP index is the basis for Vanguard’s open-end mid-cap value index fund. Take a look at the middle and right- hand charts above, which are based on index returns, not fund returns, going back to the earliest date for which we have data on both. You can see that the S&P index has outperformed the CRSP index by a compounded 9.1% return versus 8.6% for the entire period. That’s a decent half-percent per year. Even if you were to compare MidCap Value Index’s Admiral shares’ 0.09% expense ratio to the S&P ETF’s expense ratio of 0.20%, the 11 basis point difference still leaves the S&P index outperforming over time. That’s one thing to consider. On the risk side of the equation, the decision is a bit more muddled. During the financial crisis, the S&P >

100.) The first chart on the left of page 4 shows the long-term performance of Selected Value since Jim Barrow took over, plus both Donald Smith’s and Pzena’s portfolios. While MidCap Value Index didn’t come into being until August 2006, I used historical index returns for earlier months so that we could get a fuller picture. Since it’s hard to see much difference between the portfolios until the post- financial crisis period, the middle chart on page 4 focuses on that time period to give you a sense of the fairly close per- formance, but greater volatility of some of the portfolios. What I think you can see, in particu- lar, is the relationship between upside potential and downside risk. And this is over a fairly bullish period in the stock markets. I also narrowed the scope in the right-most chart on page 4 to run from the 2007 peak through the recov- eries for all the portfolios. Donald Smith & Co. is a deep-value inves- tor whose style has been successful over the long term, but with signifi- cant volatility. During the 2008 finan- cial crisis, Donald Smith’s mid-cap value strategy lost 55.0% from its high through the end of February 2009. But Pzena’s mid-cap value strategy was even worse, down a whopping 61.7% on the backs of big bets on financials. Selected Value lost 50.8%, which means Barrow and Giambrone’s portfolio provided at least some ballast to the portfolio. MidCap Value Index, by the way, dropped 56.5%, about on par with Donald Smith’s portfolio.

Lagging, Not Leading

MidCap Value Index

Selected Value

Since Jim Barrow took over 401.3% 442.1% Since Donald Smith added 126.1% 137.7% Since Pzena added 1.4% 9.3% Note: Performance data through Mar. 31, 2016.

The Independent Adviser for Vanguard Investors • May 2016 • 5

FOR CUSTOMER SERVICE, PLEASE CALL 800-211-7641