(PUB) Investing 2016

Index are the exceptions among growth funds, but both benefit from the trend toward indexing. An important reminder: Dividend Growth is not a high-yield play. It is also not a low-volatility fund. Wellington’s Don Kilbride favors com- panies that can grow their dividends, not necessarily those with the highest yields. Still, the fund has benefited from investors’ focus on dividends and funds with a history of downside protection, plus confusion over its name. Vanguard having to close Dividend Growth due to strong cash inflows reflects what inves- tors are seeking—and it’s not large growth funds. So, how should Vanguard investors like us play the large-cap growth fund options at our disposal? Without a doubt, the best growth manager at Vanguard, large or small, is PRIMECAP Management. I’ll get into the team’s individual funds in a moment. But let’s also call out the tur- keys. Unfortunately, in instances when Vanguard has hired other good managers, they are mostly buried in multimanaged funds, where their lights are dimmed.And as good as PRIMECAP is, Vanguard has picked some real losers among growth managers—Growth Equity’s abysmal track record under Turner Investments was swept under the rug when Vanguard merged the fund into U.S. Growth in early 2014. And we can all remember how long Vanguard gave the team at AllianceBernstein a pass before finally admitting the error of their ways. With a handful of ETFs in the mix, only about half of the large-cap growth funds in the Vanguard stable are active- ly managed, and only the PRIMECAP- run funds have a single outside adviser running the portfolio. Let’s take a clos- er look at what Vanguard has to offer in the space to see what our options are. Growth Index , Buy S&P 500 Growth ETF , Buy Russell 1000 Growth ETF , Hold MegaCap Growth ETF , Buy Whatever happened to indexing sim- plicity? I don’t blame investors who feel overwhelmed by the investment choic- es they face. Vanguard doesn’t make

Investors Flock to Dividend Strategies

2009 2010 2011 2012 2013 2014 2015 2016

Total

($90) ($1,683) $2,530 $15,382

Dividend App. Index Dividend Growth

$1,041 $2,806 $4,575 $2,234 $3,969

$533 $1,475 $2,507 $3,105 $3,781 $1,290 $1,985 $3,242 $17,917

$23 $2,939 $10,357

Equity Income

($153) $231 $249

$242 $1,145 $2,056 $2,607 $1,499

$637 $1,646 $2,054 $2,453 $2,756 $1,122 $3,746 $14,645 $818 $1,298 $2,549 $1,419 $2,851 $3,349 $1,665 $14,198 ($186) ($548) ($437) ($631) ($876) ($757) ($233) ($825) ($4,493) ($661) ($1,800) ($2,448) ($2,444) ($1,105) ($873) ($1,159) ($1,786) ($12,277)

High Dividend Yield Idx.

Growth Index Morgan Growth PRIMECAP Core Social Index STAR Growth PRIMECAP

($252) $1,124 ($421) ($199)

$781 ($252) ($368) ($619) ($155)

($23) $378

$344 $486 $518 $151

$39

($19)

$18

($9)

$19

$117

$135

($461) ($196) ($468) ($244)

$526 ($138)

$42 $54

Adm. Tax-Mgd. Cap. App. ($149)

($98) ($177) ($174)

$108

$85

$410 ($279) ($1,174)

U.S. Growth

($264) ($691) ($405) ($155) ($351)

$562

Note: Numbers are in millions.

aspects that lead us to choose S&P 500 Growth ETF. Standard & Poor’s, which controls the index benchmark, is more selective when constructing its indexes, and this tends to result in a portfolio of higher-quality companies. And these companies are also cheaper and somewhat larger than peers. S&P devotes more of its portfolio to tech and, importantly, health care stocks than its siblings. For my money, I prefer to partner with the team from PRIMECAP Management, but the S&P 500 Growth ETF will do in a pinch. Morgan Growth Hold. Morgan Growth took a tiny step in the right direction when one of its managers, Kalmar Investment Advisers, was handed a pink slip in January. Kalmar’s departure left four different sub-advisers sharing duties at Morgan Growth—Wellington, Jennison, Frontier and a team at Vanguard. I applaud the move to thin the manager ranks, but Kalmar was only managing 10% of the portfolio, and you’d be hard pressed to notice much of a change in the portfolio since they left. The number of hold- ings dropped from 342 to 303 in the first month after Kalmar’s exit, and the slice of the fund in the top 10 holdings only moved from 24% up to 25%—not exactly a seismic shift. With four firms still stirring the pot, no one can do too much damage on their own—but they can’t really drive performance higher, either. What inves- tors are left with is a middle-of-the- road, no-conviction mid- to large-cap growth stock amalgam. >

indexing easy when they offer four large-cap growth index funds (or ETFs) based on four different benchmarks. Unfortunately, performance isn’t much of a help in differentiating among the options. From the end of September 2010 (when Vanguard launched the S&P and Russell index-based ETFs) through August 2016, gains ranged from Growth Index’s 117.9% to S&P 500 Growth ETF ’s 124.9%. That’s a difference of about half a percent a year. Performance has been even tighter since Growth Index and MegaCap Growth ETF changed their underlying bogeys from MSCI to CRSP benchmarks. MegaCap Growth ETF at least sounds distinct from the others, but as Shakespeare wrote, “What’s in a name?” As the table on page 6 shows, S&P 500 Growth ETF is also “mega cap,” since its median company is $88.9 billion in size, which isn’t far behind MegaCap Growth’s $95.8 billion median. The table pretty much confirms that the portfolios of all four index funds look awfully similar. Technology and consumer-related companies make up about half of the portfolios, while ener- gy, telecom and utility companies bare- ly make the cut. Apple and Alphabet (formerly Google) are the top two hold- ings across the board. In fact, the same six companies make up the top six holdings in each fund. Where the rubber meets the road, in the Growth Index Model Portfolio , Dan and I recommend S&P 500 Growth ETF. Yes, at 0.15%, it isn’t the cheapest of the options. In isolation this might be a deal breaker. But there are a few

The Independent Adviser for Vanguard Investors • October 2016 • 5

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