(PUB) Investing 2016

Assigning four firms to this fund reduces the impact of a single manager misstep, but at the same time limits the ability of any one manager to add significant value. Further, it should be noted that the sleeve managed by Wellington is composed of stocks selected by a team of global industry analysts. So there are actually dozens of cooks stirring the portfolio pot here. I believe this fund is another clas- sic case of Vanguard handicapping its active managers so heavily it ensures a boring race. European Index Hold. As I mentioned earlier, European Index recently picked up a new bogey, the FTSE Developed Europe All Cap index, which adds small-cap stocks into the mix. Based on historical data for the old and new indexes, the addition of smaller stocks has only added marginally to perfor- mance over the dozen or so years for which data is available. So, it’s not as if a supercharged index fund has emerged from this shift. I’m sure investors are more con- cerned about the impact of the Brexit vote and negative interest rates than Vanguard tweaking its indexes. To buy European Index today, you’ve got to believe two things: First, that the aforementioned uncertainties are creat- ing opportunity, and second, that an indexed approach is the best way to capture those opportunities. I can get on board with the first idea—though I don’t think you need to rush into the space—but I stumble at point number two. I’d prefer to invest with a manager who can sort through the winners and losers that will emerge as the uncertainties in Europe evolve. Dan and I have never been a big fan of Vanguard’s regional foreign funds, because, well, active managers have shown they can outrun the indexes pretty darned consistently. As the chart above shows, over the past dozen years or so, European Index and Pacific Index’s relative per- formance against Total International Stock has been all over the map, and ultimately, all three funds led you to

207.3%, while Total Stock Market Index only gained 20.1%. Before you get caught up in those returns, consider that diversification can cut the other way: From the end of 2007 through June 2016, Emerging Markets Index lost 7.3% as Total Stock Market Index gained 84.7%. I know that there will come a time when U.S. stocks’ dominance over foreign stocks will end—I just don’t know when. For now, Dan and I are comfortable allowing the managers at International Growth decide when it makes sense to allocate to this risky but potentially rewarding part of the global market. Emerging Markets Select Stock Hold. Vanguard’s first move into active management in the emerging markets was a cautious one—doling out portions of this fund’s portfolio to four separate firms: Wellington, M&G Investment Management, Oaktree Capi- tal Management and Pzena Investment Management. The fund celebrated its fifth birthday at the end of June. It wasn’t exactly an auspicious start. Emerging Markets Select Stock is down 7.4% since inception, while Emerging Markets Stock Index is off 12.1%. The fund’s relative performance, as you can see in the chart below, was strong in the early innings, but it faded fast in 2014. Yes, the active fund has clawed back some relative performance over the past 18 months, but so far I’d describe the performance as average, and I’m not convinced we’ll see anything more than that going forward.

Relative Performance Changes Quickly

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European Index vs. Total International Index Pacific Index vs. Total International Index

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essentially the same place over the entire period. Finding the right entry and exit points would be incredibly tough to do. What advantage do you think the indexes have over the experts? Global Equity Hold. Firing AllianceBernstein may have been one of the best moves Vanguard’s ever made. (After axing former Growth Equity manager Turner Investments, that is.) Not only did AllianceBernstein do a terrible job running domestic growth stocks, but since being taken off the roster at this world-stock fund and handing much of its portfolio allocation to Baillie Gifford, Global Equity has begun to show some of its old luster. Original manager Marathon Asset Management generated strong returns when Global Equity got its start. Today, Marathon’s allocation in the portfolio is down to a third of assets, and Baillie Gifford and Acadian each run anoth- er third. Since redistribution of assets occurred around March 2013, Global Equity has outperformed Total World Stock Index, with about the same allo- cation of U.S. and non-U.S. stocks, ris- ing 28.3% compared to the index fund’s 24.9% gain. I was able to find individual global equity returns for each of the three sub- advisers, and while these numbers may not be exact replicas of the managers’ history on Global Equity, it does give us a chance to look under the hood of the fund. Acadian, which runs a com- puter-driven strategy, is the weak hand. Since Baillie Gifford came on board

EMSelect Stock vs. EM Index

0.94 0.96 0.98 1.00 1.02 1.04 1.06 1.08 1.10 1.12

Rising line = Emerging Markets Select Stock outperforms

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The Independent Adviser for Vanguard Investors • August 2016 • 13

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