(PUB) Investing 2016

what riskier style, searching for deeper “value” than Barrow. Under Barrow and Giambrone’s solo tasking, Selected Value ran with about 40 stocks and a third of assets going to the top-10 hold- ings. With Smith on board, the portfolio consistently held 60 to 70 stocks, with about 25% of assets in the top holdings. Then, in March 2014, Vanguard hired a third sub-adviser, Pzena Investment Management. Pzena also manages piec- es of Windsor and Emerging Markets Select Stock , in addition to the overseas U.S. Fundamental Value for Vanguard. The firm has quickly become respon- sible for about 15% of the fund— largely at the expense of Barrow and Giambrone’s allocation. Since Pzena joined, the number of holdings has drifted up to 120 or so. While it’s hard to assess who is impacting performance, since Pzena joined Selected Value, the fund’s 5.6% gain has trailed MidCap Value Index’s 15.6% return and S&P MidCap 400 Value ETF’s 13.1% advance. In the past, Selected Value has held up rela- tively well in down markets, but given Pzena’s track record of focusing on financial stocks, which generated large losses in the credit crisis, it is not clear that Selected Value will be as defensive as it once was. This is a situation where I would’ve liked to have seen Vanguard close the doors rather than adding managers. Strategic Equity Hold. Like Capital Opportunity and MidCap Growth, I discussed Strategic Equity in the aggressive growth fund roundup, but it too falls into the mid-cap space. Vanguard’s Quantitative Equity Group runs this computer-driven fund, meaning the managers program the computers and the computers do the stock picking. While there have been stretches when the computers picked stocks well, there’ve also been runs when they haven’t. The bottom line is that you would’ve been better off just owning MidCap Index and not worry- ing about Vanguard’s programming. Of course, you know that I think you can do even better partnering with the stock pickers at PRIMECAP Management. n

fund’s track record as if this complete management change didn’t take place. Don’t be fooled. The relevant track record starts in mid-2006 when the two replacement managers, Chartwell Investment Partners and William Blair & Co., got up to speed. Since MidCap Growth Index’s incep- tion (just a couple months after MidCap Growth came under new management), MidCap Growth has gained 117.0%, while the index fund has gained 108.6%. Sounds good, right? Unfortunately, if it weren’t for about 20 weeks from late June 2008 through late November 2008, when this fund went on a short-lived tear (based, I believe, on a few great stock picks), the story of their relative perfor- mance would be reversed. Or consider that the S&P MidCap 400 Growth index (not the fund, which launched in 2010) gained 150.9% since MidCap Growth Index’s inception— merely changing the benchmark alters the story. You also would’ve been better off owning any one of the PRIMECAP- run funds. Since the reboot, the active fund has outperformed when markets stumbled (such as 2008 and 2011), and lagged when markets rallied. That may appeal to some, but one great 20-week peri- od out of a decade-long track record doesn’t convince me this fund is mate- rially better than the index or worthy of our investment dollars. Selected Value Hold. Once a standout—if unrecog- nized—fund, Vanguard watered down Selected Value with too many manage- ment teams. Primary managers Jim Barrow and Mark Giambrone are quintessen- tial value investors looking for stocks whose prices relative to earnings or book-value are below the market’s mul- tiples while generating a decent dividend yield. Dividends afford Barrow and Giambrone patience—they are essen- tially being paid to wait for the market to recognize the value of their holdings. A decade ago, Donald Smith, of Donald Smith & Co., was added to the mix to handle about one-quarter of the fund’s assets. Smith practices a some-

inception. The latest change came in July, when Peter Higgins was dropped from the fund, leaving his Wellington Management colleague David Palmer as the sole manager. Palmer was originally added to Capital Value in December 2009 to tone down the high-octane opportunistic strategy that Higgins practiced. It is not clear how successful Palmer was in that effort, and under the dual management structure, Capital Value returned 70.8% while Total Stock Market advanced 114.1%. But since going solo, Palmer has wasted no time in making Capital Value’s portfolio his own. In the first month after Higgins’ departure, the number of stocks went from 153 down to 88, the percentage of assets in the top-10 holdings increased from 20% to 26%, and the median company size increased from under $12 billion to over $26 billion. The first month also saw dramatic changes in sector weights, as financial stocks jumped from 21% of the portfolio to 28% (though, in September, Palmer cut financial stocks back down to 22% of the portfolio), and technology stocks were cut from 17% to 11% of assets. Given the lack of single-manager funds at Vanguard, Capital Value is one to keep an eye on, but it is not entirely clear how the fund will per- form with Palmer steering the ship on his own. Since recommending that investors with a penchant for trading buy the fund at the end of September 2015, Capital Value has rung up a 8.9% return, lagging Total Stock Market Index’s 12.3% return. Dan and I are reassessing our three-year trading strategy for Capital Value given the potential for lower volatility, if that’s what truly happens. But for now we’re sticking with it, and suggest you do as well. Our continuing “Buy” on the fund reflects that thinking. MidCap Growth Sell. MidCap Growth was over- hauled a decade ago when the fund’s original manager was shown the exit. As Dan and I discussed in the August newsletter, Vanguard talks about the

The Independent Adviser for Vanguard Investors • November 2016 • 7

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