(PUB) Investing 2016

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of Vanguard’s other large-cap growth funds. It’s no longer the dog that it once was, and hence Dan and I raised its rat- ing to a Hold at the end of last year, but under its plethora of managers, the fund doesn’t stand out as a market-beater, either. It’s a shame this fund can’t be juiced up by trimming its management structure, because Vanguard could use a good, well-managed large-cap growth fund that’s open to new shareholders. As it stands, this one doesn’t fit that bill. n

saving name blind you to the other options available at lower minimums.

(since rebranded as Jackson Square Partners) and Wellington Management, the fund’s 124.8% return through August 2016 compares favorably to Growth Index’s 117.9% gain and isn’t far behind PRIMECAP’s 127.0% advance. But in February 2014, U.S. Growth picked up two additional sub-advisers, Baillie Gifford and Jennison, when assets from the abysmal Growth Equity were merged into the fund. As you can see in the table on page 7, U.S. Growth simply isn’t that different from the bulk

U.S. Growth Hold. Has U.S. Growth been reborn, and is it worthy of your dollars? The short answer is that it’s moving in the right direction, but still hasn’t earned a place in your (or my) portfolio. It’s true that U.S. Growth has sta- bilized. Since Vanguard finally fired AllianceBernstein in the fall of 2010 and replaced themwithDelaware Investments

MANAGEMENT Growth & Income Is Back

SEPTEMBER’S END marks five years since Vanguard completely revamped Growth & Income , a quant fund that had once produced strong, long-term market outperformance and then fell off the rails. It was September 2011 when Vanguard fired long-time manager Mellon Capital Management (formerly Franklin Portfolio Assoc.) and replaced them with a trio of quantitative managers—D.E. Shaw, LA Capital and Vanguard’s quant group. The change to the portfolio was immediate. As the chart on the left shows, the number of stocks in the port- folio almost quintupled in one month and concentration in top holdings fell from 28% to 20%. The portfolio has doubled again, with more than 1,100 stocks at the end of August. Not surpris- ingly, then, concentration has continued to fall, and now is hovering around 16% of assets in the top 10 holdings. Performance has improved, though the argument boils down to basis points. You can see in the chart on the right that Growth & Income’s relative outperfor- mance is small. In the chart, the line rises when Growth & Income (which is benchmarked against the S&P 500 index) outperforms 500 Index . Over the five years the new management triad has been in place, the fund has only outpaced 500 Index by about 5.5%. Its five-year annualized return of 16.8% is just 60 basis points better than the index fund’s 16.2% return.

More Stocks, Less Concentration

Growth & Income Ekes Out Superiority

1200

33%

1.04

Stocks in Portfolio % in Top 10

Rising line = Growth & Income outperforms 500 Index

1000

30%

1.03

800

27%

1.02

600

24%

1.01

400

21%

# of Holdings

1.00

Concentration in Top 10 18%

200

0.99

0

15%

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When I looked at performance on a more granular level I found that on a monthly basis Growth & Income beat 500 Index about 50% of the time, by about 12 basis points on average. Still, that’s enough to outpace the index fund, which, when it outperforms, only gains about eight basis points on the active fund, on average. As I said, this is a basis-point argument. Many years ago, when Growth & Income was in its index-beating heyday, I used to recommend that investors only use the fund in tax-deferred accounts, because its after-tax returns weren’t able to match the index fund’s returns. That’s still the case. 500 Index has a tax efficiency of a bit more than 97%, which means that after taxes on distributions, shareholders keep about 97% of the fund’s returns. Growth &

Income’s tax efficiency over the past five years has run a bit under 88%. And that makes a difference. In fact, over the five years ending in the second quarter, Growth & Income’s 4.2-percentage- point advantage over 500 Index turned into a 3.5-percentage-point deficit once taxes were considered. Investors in higher tax brackets should absolutely choose 500 Index over Growth & Income. Tax-exempt investors can use Growth & Income as a substitute for the index fund, and if history is repeated, will earn a slightly better return over long periods of time. It’s your pick, and with five years under their belts, I’m going to change my rating on the fund from Sell to Hold. It would be a Buy if it signifi- cantly outperformed its benchmark, but it doesn’t. n

14 • Fund Family Shareholder Association

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