(PUB) Investing 2016

PRECIOUS METALS Watch Out for the Gold Bugs

DON’T LOOK NOW, but there’s a very good chance that money is going to begin cascading back into Precious Metals & Mining . And if it does, Vanguard could quickly slam the doors on this volatile and risky fund. Not strictly a gold fund (its mandate was broadened in 2004, though gold is still a huge factor), Precious Metals & Mining has turned the performance corner in a big way. Its one-year return turned positive in April, its three-year return turned positive in June, and the fund is up 70.2% since the beginning of 2016, putting it on pace for its best single calendar year since its 1984 inception. With $3.0 billion in assets, the fund has more than doubled in size in six months. Almost all of that gain has been performance-based, with a net $43 million in cash added through July. But history suggests that the trickle of new money is about to turn into a

fund was up an annualized 6.7% over the past three years. Would I buy this fund? No way! Despite the incredible run it’s had this year, the fund’s long-term shareholders are still trying to erase a 75.9% loss. The fund remains deeply underwater compared to the high reached on May 19, 2008. This is by far the riskiest of Vanguard’s offerings, and also the one tied to an asset that simply has no intrinsic investment value. I’d stay away, but watch with curiosity as others try to time their entrance and exit here. It’s a good bet that if the hot money starts to flow, Vanguard could shut the doors quickly. So far there’ve been no signs of excess, but flash floods don’t give much warning. So long as performance stays strong, I expect that the money will flow. But once it grows cold, the money will go. n

Vanguard’s Fund Strikes Gold

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Precious Metals & Mining Price of Gold

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flood. Traders have been attracted to the fund, with a bit of a lag, almost every time its three-month returns have turned positive. While Precious Metals & Mining’s three-month return was -12.5% in January, it turned positive, to 19.4%, in February, and has remained in positive territory since. At the end of July, the

And finally, the risk piece of the equation. Alternative Strategies was just one-third as volatile as Total Stock Market over the past year. Or if you prefer to look at the fund’s maximum cumulative loss, Alternative Strategies’ largest decline since its inception was a drop of 2.5%. Total Stock Market’s worst slide during that period was a drawdown of 7.6%. Near double-digit returns with low risk and low correlation to stocks and bonds are exactly what you’d want from an alternative strategy. However, there are a few things to keep in mind before you say, “Sign me up!” First, as I mentioned, the fund isn’t available to individual investors. And even if Vanguard does make it available, using Market Neutral’s minimum investment hurdle of $250,000 as a guide, it probably won’t be within reach of most investors. Second, the fund is very small and hasn’t caught the eye of many of the endowments and pensions that Vanguard is targeting. Of the $192 million invested in the fund, $165 million or so can be attributed to Managed Payout, which allocates about 10% of its assets to the new fund. (It probably goes without saying, but I wouldn’t invest in Managed Payout just to gain access to Alternative Strategies.) Some funds do very well when the portfolio is small, and then struggle as assets grow. It is not clear how large a portfolio Vanguard can suc- cessfully manage in this strategy. Third, let’s say Alternative Strategies was available to everyone with a minimum hurdle that didn’t break the bank, and the size of the fund wasn’t a worry. Should everyone allocate some of their portfolio to the fund? No. I believe that people should only invest in what they under- stand. If “long/short equity, event driven and fixed income relative value”

sounds like gobbledygook to you, then you shouldn’t invest in the fund. Owning a mix of plain old stock and bond funds has served us well in the past—and will continue to in the future. On top of that, Alternative Strategies hasn’t and shouldn’t behave like the stock and bond funds in your portfolio. While that is by design and a strength of the fund, it does mean that some investors may find it dif- ficult to hold on to. Consider that in Alternative Strategies’ first 12 full months, it underperformed Total Stock Market in six months. And when it underperformed, Alternative Strategies lagged the index fund by an average of 3.7%. Over the three months when Alternative Strategies was experiencing its largest drawdown of 2.5%, Total Stock Market was gain- ing 9.6% and Total Bond Market was up 1.3%. Remember, when something is uncorrelated, that means there will be times when it lags the other pieces of your portfolio. To reap the ben- efits of a diversified, uncorrelated holding, you either have to time your buys and sells precisely, or you’ve got to hang on through those difficult periods when it is a drag on your returns in order to be there when the diversification works in your favor. Easier said than done. With an expense ratio of 0.73%, the fund is expensive by Vanguard standards, but far cheaper than similar strategies available to mutual fund investors—and certainly cheaper than the average hedge fund. I suspect that if Vanguard opened this strategy more broadly, it would be very popu- lar, if only for its low-fee advantage. And if the fund continued to deliver differentiated, yet positive returns, its appeal would only increase to the point of making it unmanageable. For the time being, Vanguard seems con- tent to leave Alternative Strategies in relative obscurity.

The Independent Adviser for Vanguard Investors • September 2016 • 5

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