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FFSA

Award
Winners:
Best and Worst
Vanguard Funds
Dan Wiener, Editor, Independent Adviser for Vanguard Investors

SPECIAL REPORT

Award Winners
Y ou r V a n g u a r d Actio n P la n
By Dan Wiener

Id like to welcome you as the newest member of the Fund Family Shareholder Association (FFSA).
Your investing success is my number-one priority.
FFSA members who have been with my newsletter serviceThe Independent Adviser for Vanguard
Investorsfor the last decade know the value of having an investment strategy in place that beats the
market over the long haul.
Before I name my award-winning Vanguard fundsand those to stay away fromI want to begin by
giving you some real, actionable advice to address the topics many investors are asking me about now. I
have organized your Action Plan into investors top areas of concern.
Concern #1: Is indexing the whole stock market always the best way to invest?

Action #1: Make sure you choose the RIGHT index funds.
While 500 Index and Total Stock Market Index generally get all the attention, dont forget that when
you index the whole market, you get all the dogs. Personally, I favor the managers in my Growth Model
Portfolio, but for those who want to index, I provide a Growth Index Model Portfolio as well. See page 2
of the latest monthly newsletter or the portfolio page of www.adviseronline.com for more.
Concern #2: How can I reduce the impact of fees on my portfolio?

Action #2: Dont pay more than you have to.


Vanguard is known for its low fees and great customer service. But you may not know that there are
ways you can pay even less for your investments.
If you and your family have accounts at Vanguard, hold a family meeting today and agree to present
a united front. Ask Vanguard to calculate all your accounts together to try to meet the minimums for
Vanguards higher levels of serviceFlagship Select ($10 million), Flagship ($1 million), Voyager Select
($500,000) and Voyager ($50,000). That way youll receive your own account representative and annoying small-account fees can be waived.
Finally, Flagship and Flagship Select investors can get into some of Vanguards closed funds, including
PRIMECAP and PRIMECAP Core.
Concern #3: What if I hold funds in a taxable account?

Action #3: Be a tax-smart investor.


If you are readjusting your portfolio or making tax moves at the end of the year, here are a few
tips to remember. First, before you sell, you should consider tax implications. If you have a gain
and intend to donate to a charity this year, ask Vanguard about your gifting appreciated assets. If
you are selling only a part of a fund, remember not to reinvest distributions automatically in a tax 2013 InvestorPlace Media, LLC

able account. Instead, have them directed


to a money market account. You still pay
taxes on the distributions, but you wont
pay them again as you would if you were to
sell shares to rebalance your portfolio. Also,
whenever you rebalance, decide if you can
just reposition holdings in your tax-deferred
accounts rather than sell funds in a taxable
account.

the one state-specific muni that I have a buy


on today.
Concern #5: What do you think about
annuities?

Action #5: Use them as a last resort.


If youre thinking about bonds and safety,
you may also be thinking about variable
annuities. Many investors think of variable annuity funds as safe. But youre really
taking as much risk with your investments
here as you are in any other mutual fund,
and annuities cost more, which lowers your
returns. Before you buy them, you should
make sure to max out all your other taxdeferred investment options. Once youve
done so, you can then turn to annuities. When
you do, my advice is to go for growth in a
portion of your annuity portfolio. The best
growth fund in Vanguards annuity lineup
is Capital Growth Annuity, run by the
PRIMECAP Management team.

When you do sell, calculate how to best


figure the sale on your tax forms. Try to balance capital gains with any capital losses,
and remember that up to $3,000 of ordinary income can be offset by a capital loss.
Finally, after you sell, remember why you
are investing, and enjoy the purchase or
activity that you have chosen, made possible
by your investing wisely.
Concern #4: Is now the time to invest in
bond funds?

Action #4: Avoid long-term bonds.


The last few years have shown that bond
funds can do very well. Just compare the
5-year return of Vanguards Total Bond
Market to that of Vanguards Total Stock
Market.

Concern #6: How do I benefit from


Tech Winter?

Unfortunately, massive supply, unceasing


demand, and low, low rates are an explosive
mixture and are set to combine to give some
investors a massive crash from their sugar
highs in the years to come. But the news is
not all bad. Here is what you can do with
bond funds.

Before closing, Id like to mention the tech


sector and how it relates to your funds, since
I get a lot of questions about that. Each
November marks the start of a four-month
trend that I call Tech Winter. During this
period, the tech sector has historically performed well. A few reasons for this include
increased fourth-quarter corporate spending
and a rebound in European sales after generally slow summers. (Europe accounts for a
significant percentage of U.S. tech orders.)

Action #6: Stay in good funds with


above-average tech holdings.

If youre not pleased with your money market


yields, you can consider Vanguards ShortTerm Investment-Grade (VFSTX), formerly
Short-Term Corporate, bond fund as a substitute. Its holdings very short maturities make
it a higher-powered money market substitute.
You can read more about the fund later in this
report.

Should you just lump all your investments


in tech during this time simply because of this
theory? No. Instead, Id suggest you
stick with some of my recommended funds
with above-average tech holdings such
as Capital Opportunity (VHCOX) and
PRIMECAP Core (VPCCX).

If youre looking for a state-specific muni


bond fund, most of Vanguards are in the
long-term categoryall but one. California
Intermediate Tax-Exempt (VCAIX) is
Action Plan

for

Concern #7: How do I know what funds


Vanguard Investors
4

(or, for those who sold their shares, after


taxes on distributions and sales of fund
shares) were for the period reported.

to buy?

Action #7: Keep reading.


With so many mutual fund choices available to investors, picking the best ones for
your portfolio certainly isnt always easy.
Vanguard offers more than 170 funds in its
family alone. You need to choose the right
funds to diversify and balance your portfolio, and thats why I give you my favorite
Vanguard funds in this report.

But for a complete at-a-glance reference, I


periodically do a comparison in my newsletter
of tax efficiency and after-tax returns among
all Vanguard funds. Some of my favorite
funds have great returns and are very taxefficient. For my latest thoughts on tax efficiency, you can check the news articles and
newsletter issues at www.AdviserOnline.com
each year around tax-time. Of course, with the
huge losses many funds sustained in the latest
bear market, tax efficiency is likely to be high
across the board for some time.

One way to measure funds is by looking at their


tax efficiency. But as Ive said for years, when
the question of taxes raises its head, its not tax
efficiency that matters so much as the after-tax,
or tax-adjusted, return.

Now lets move on to my award-winning


Vanguard funds. These funds (listed on the
next page) are the best of the best funds at
Vanguard, and I urge you to consider them
for long-term growth. So without further ado,
turn the page to learn more about the FFSA
Award Winners.

You can find Vanguards reported after-tax


returns for a particular fund on the funds
profile at the Research Funds & Stocks section of the website. Just click on Price &
Performance and scroll down to After-Tax
Returns. That will show you what the funds
estimated returns after tax on distributions

Action Plan

for

Vanguard Investors
5

FFSA Award Winners


The Best (and Worst) Vanguard Funds

anguard offers more than 170 mutual


funds, which can make choosing the right
one a daunting task. And, lets face it,
Vanguards funds come in all varieties. Some
are very good funds, others, averageand some
could stand a lot of improvement. Thats why
I want to talk to you about my top Vanguard
fundsthe funds that you can build a portfolio
around. These funds shine the brightest in the
Vanguard firmament. I call them Award Winners.
There are no guarantees, of course, but over the
long haul, these funds and the managers who run
them have proven to be the cream of the crop of
Vanguard funds. And the winners are:








the markets 28.7% return. In 2010, it gained


19.4% versus 17.1% for the market. It lagged
slightly in 2012 but still put up double digits,
then ran ahead again in the first half of 2013.
The fund, which used to be an all-Barrow
portfolio, has undergone some changes, but its
newest management team, Donald Smith & Co.,
handles about one-quarter of the funds assets
and has a somewhat riskier style, searching for
deeper value than Barrow.
Because Selected Values mandate is to invest
in smaller companies than youd usually find
in Windsor II, Barrows other major responsibility, this is definitely a growth fund. And
Smiths deep-value style has growth written
all over it. But because these managers wont
pay up for the stocks they own, its also a value
fund through and through. Barrow doesnt buy
expensive stocks hoping theyll become even
more so. He buys cheap and holds until they
become fairly valued.

1. Selected Value (VASVX)


2. Capital Opportunity (VHCOX)
3. PRIMECAP Core (VPCCX)
4. Dividend Growth (VDIGX)
5. Health Care (VGHCX)
6. International Growth (VWIGX)
7. Wellington (VWELX)
8. S&P MidCap 400 Growth (IVOG)
9. Short-Term Invest.-Grade (VFSTX)

The portfolio is eclectic. Tobacco stocks, financials, a cruise-ship operator and an oil service
company can be found in Selected Values mix.
And thats what makes it appealing. Barrow
picks his companies one by one, from the bottom
up. Ive always been a fan of his no-nonsense
stock-picking style. While he could retire soon,
or at least scale back his involvement (I suspect
Giambrone will succeed him), we still have plenty of time to enjoy the ride. By the way, Jim also
says he has a good chunk of his own money in
the fund. I do, too.

Winner: Selected Value


One of Vanguards best funds, Selected Value
doesnt always get the attention it deserves. I first
advised Fund Family Shareholder Association
(FFSA) members to buy the Selected Value fund
in 2001, and we havent been disappointed since.
Selected Value cant make money when the entire
market is falling, but main managers Jim Barrow
and Mark Giambrone have been able to keep more
of the profits theyve earned for us from being
wiped out than most other managers. And as the
markets have moved up, so has Selected Value.
From the markets bottom in the fall of 2002
through the end of 2003, Selected Value climbed
more than 40%, compared with the stock markets 32% rise. In 2009, it shot up 36.3% versus

Winners: Capital Opportunity


and PRIMECAP Core
The team at PRIMECAP Management, which
runs not only Capital Opportunity but also
Vanguard PRIMECAP, is one of the best in
Vanguards stable of funds. Since taking over
Capital Opportunity in 1998, theyve done a

FFSA Award Winners


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bang-up job for investors whove held on to their


shares, and I expect them to continue doing so.

problem for closed funds. Thats not the case at


the Odyssey funds. I highly recommend them and
use them for most of my private clients accounts
at Adviser Investments, as well as in my own personal account.

Back in 1998 when the fund was faltering,


others were saying sell, but I said buy. And
FFSA members and I put so much money here
that Vanguard finally closed the fund to new
investors. Vanguard decided to reopen Capital
Opportunity and its big brother PRIMECAP in
April 2001 to new investors, albeit at a $25,000
minimum. In 2004, both funds once again closed
to new investors, though Capital Opportunity
finally reopened in April 2013.

The one exception to the outperformance rule


between the Vanguard PRIMECAP funds and the
PRIMECAP Odyssey funds is PRIMECAPCore.
Opened in December 2004, its one of the best
funds at Vanguard.
As the name implies, PRIMECAP Core is a bit
more core compared to the other PRIMECAPrun Vanguard funds, with a higher yield, more
exposure to larger companies, and more of a
value orientation than Capital Opportunity. Of
course, following in the footsteps of the other
PRIMECAP funds, PRIMECAP Core was closed
to new investors in 2009. But there are alternatives. See the notes on page 2 of the monthly
newsletter for details, and check out page 27 of
my Answer Book for Vanguard Investors for more
tips on how to deal with closed funds.

Capital Opportunity (like other PRIMECAP


offerings) is a GARP, or growth-at-a-reasonableprice fund. That means that, like most growth
investors, its managers look for companies
with rapidly growing earnings. But unlike the
growth-at-any-price managers like those that run,
say, Vanguards U.S. Growth fund, the folks at
PRIMECAP Management dont like to pay big
bucks for good earnings prospects. Theyll only
pay a reasonable price. To wit, this GARP strategy
is a winner and has played out beautifully in the
arena where Capital Opportunity invests.

Winner: Dividend Growth

No, the fund will not always be a one-way ticket


to greater wealth. There will be times when it
suffers just like the rest of the market. But the
long-term record is excellent, and the even longerterm record of the management team is superb.
I believe that as long as the PRIMECAP team
keeps running this fund, it will remain a solid
long-term investment.

Dividend Growth is a large-cap fund whose holdings serve as a counterpoint to more growthy
stocks found in other funds in my Model
Portfolios. While the dividend yield is not sumptuous, at around 2%, the companies in this fund
tend to be quite different from what youll find
in, say, one of the PRIMECAP-managed funds.
Wellington Managements Donald Kilbride is a
value investor with a laser-like focus on companies that he feels can grow their dividends. That
doesnt mean they necessarily have big yields
to start with. It means these are companies that
Kilbride believes have the will and the means to
increase dividends, and as they do, that investors will pay a higher price for the stock. One
thing I like about this fund is Kilbrides concentrated portfolio of just 50 stocks or soa far cry
from the hundreds found in many growth and
income funds.

But for even better results, you have the option


of choosing another winner from PRIMECAP
Managementthe PRIMECAP Odyssey
Aggressive Growth Fund (POAGX), one of
PRIMECAP Managements private-label
PRIMECAP Odyssey funds. The Odyssey funds
are available through Vanguard Brokerage,
Fidelity and Charles Schwab or direct at
www.odysseyfunds.com.
The PRIMECAP Odyssey funds have low minimums of $2,000 and are smaller and nimbler
than their Vanguard counterparts, and packed
with PRIMECAP Managements best and newest
ideas. Its always tough to manage funds when
more cash is flowing out than in, which can be a

Not surprisingly, given his desire for yield, and


the ability to add to it, Kilbride owns some big
oils, as well as a smattering of consumer stocks,
and even some techs. What he doesnt own is

FFSA Award Winners


7

much in the way of utilities, which are heavily


regulated and, hence, cant necessarily grow their
dividend streams at a fast enough pace to suit
Kilbrides tastes.

too soon to tell if the addition of a third manager


will help or hurt the cause here, though there are
signs that all remains well at the fund.
I always considered this funds former lead manager Richard Foulkes one of the best of the breed
among international investors. Since Foulkes
retired in Oct. 2005, the team at Schroder
Investment Management led by Virginie
Maisonneuve has taken over approximately 35%
of this funds $19 billion portfolio.

Indexers might ask why not invest in HighDividend Yield Index or Dividend Appreciation
Index instead. The answer is simple: Since he took
over, Kilbride has made mincemeat of these index
funds, and I believe he will continue to do so.

Winner: Health Care

The fund has three managers, with Baillie


Gifford handling a little under 50% of assets
and M&G Investment Management handling
about 10% or so (some money is held in cash by
Vanguard). Whats encouraging about this trio is
that the portfolio hasnt blossomed to hold hundreds of stocksit currently has about 180 or so,
and the top 10 represent around 20% of assets. A
reallocation of assets may have helped the fund,
and Im always happy when having three managers doesnt mean having 500 stocks. With growth
stocks presenting some decent opportunities, this
fund is a good option as a core foreign holding.

Two questions must be asked, and answered, to


get comfortable with Health Care, the sector fund
thats been a component of my Model Portfolios
for the greater part of the past two decades. First,
does it make sense to overweight health care
stocks in a portfolio? Second, if you answered
yes to the first question, should you do so by
indexing?
Ill answer the second question first because its
easy: Unless youre an efficient market acolyte
through and through, do not index this sector.
While Vanguards Health Care ETF (VHT)
may outpace other index funds, ETFs and active
funds focused on the health care sector, it just
cant hold a candle to the team at Wellington
Management that runs Health Care and the smaller Hartford Global Health (HGHAX).

The managers have gone against the grain a bit,


adding to companies in emerging markets as
prices there have tumbled. That kind of contrarian
thinking should make the fund a long-term winner.
In the current global turmoil, larger companies
may sail a slightly more stable course. This fund
should do a good job of staying on an even keel,
though, like most other funds, it took a drubbing in
the latest market downturn.

As to whether we want a health care overweight,


my answer is yes. Demographics, innovation,
a global focus, good dividend yields and a longterm record of market outperformance with less
than market risk are all key ingredients in my
choice of this fund.

Winner: Wellington

While manager Jean Hynes may have big shoes


to fill after the retirement of former manager Ed
Owens at the end of 2012, the team she leads,
which Owens built over many, many years at
Wellington Management, is well-versed in the
value-oriented strategy that has made Health Care
such a winning investment. I remain confident in
Hynes and continue to recommend the fund as a
core, long-term holding.

In all of the calendar years since 1997, Wellington


only lost money twice. The fund, which is more
than three-quarters of a century old, has been stalwart through some of the worst stock and bond
bear markets in history. Like the Energizer bunny,
however, it just keeps on going. While many
investors group Wellesley Income and Wellington
together, theyre quite different. Having a smaller
commitment to bonds than its younger sibling,
Wellington has generated better returns over time,
particularly after horrific bond markets.

Winner: International Growth


This fund consistently outperformed the EAFE
Growth index for almost the last two decades. But
recently its course has been a bit more jagged. Its

Because Wellington does not have as great an


income objective to satisfy as Wellesley Income,

FFSA Award Winners


8

equity manager Ed Bousa can cast a wider net


in the search for securities that can make this
fund perform. For instance, the largest sectors in
which the fund is invested are financial services
and health care, yet there is a smattering of holdings in virtually all sectors of the marketseven
technology, energy and industrials. And for
such a large fund, holding only about 100 stocks
means Bousa is giving shareholders his best
ideas, undiluted.

Somehow, it seems to work. S&Ps growth


indexes simply outperform. Even in 2011, in
spite of a heavier allocation to financials, the
S&P option did better.
Vanguard recommends that you compare this
ETF to MidCap Growth ETF, which tracks the
same market segment at a lower cost.
But based on the historical performance of the
underlying indexes, the S&P ETF outperformed
its peer significantly over the long run. If you are
looking for a mid-cap growth ETF, S&P MidCap
400 Growth ETF is a better choice, despite the
small difference in cost.

Like Wellesley Income, Wellingtons mandate for the income portion of its portfolio was
changed in 2000 to reduce the funds interest-rate
risk. Not a great time to make the change, but
over the long haul, a good move. Its bond holdings are now measured against an intermediateterm, rather than a long-term, benchmark.

Winner: Short-Term
Investment-Grade
This is my favorite Vanguard fund at the short
end of the yield curve. Formerly called ShortTerm Corporate, it is extremely safe, produces
steady returns, and offers some diversification
that the Treasury and Federal funds dont. Rather
than investing only in Treasury, Agency or
other government-backed securities, Short-Term
Investment-Grade invests in high-quality corporate bonds, asset-backed bonds and a smattering
of other non-Treasury securities. The combination responds to rising or falling interest rates
less rapidly than Treasurys, meaning that it rises
a bit slower when rates drop and falls a bit less
when rates rise, since its excess yields protect
investors and prices. Over time a portfolio like
this one will outperform a Treasury portfolio, as
this one has.

One note: After taxes, investors have been able


to keep a lot more of what they earn in this fund
than they have from Wellesley. So if youre in
a high income tax bracket, this fund looks even
more appealing, assuming you dont want to
balance your holdings between stock funds and
municipal bond funds.

Winner Index: S&P MidCap


400 Growth ETF
Heres a conundrum. Among Vanguards openend mutual funds, I think MidCap Growth
Index is a Buy. But when you include ETFs
in the mix, well, my allegiance goes to S&P
MidCap 400 Growth ETF, one of nine ETFs
introduced in September 2010 based on Standard
& Poors indexes.

I use this fund as a higher-yield cash substitute


in my Model Portfolios and would recommend
it in that role for most any portfolio invested for
the long haul. Of critical importance from a portfolio diversification/safety standpoint is that this
fund seldom loses money.

Consider that while the two funds own about the


same number of stocks, their top holdings are different, the allocation to those holdings is different,
and, despite reaching down to slightly smaller fare,
the S&P portfolio is cheaper on both price-to-earnings and price-to-book-value measures.

Before the unprecedented events of fall 2008, the


worst losses suffered by investors in Short-Term
Investment-Grade were quite smalla worstcase 2.2% loss over three months, a 1.0% loss
over six months and a mere 0.1% loss over 12
months, all occurring in 1994, when the Federal
Reserve began a sharp and fast series of interest rate hikes that saw the Fed Funds Rate move
from 3.00% to 4.75% in six months. Since 1994,

Whats happening here is that while the stock


selection in the index that MidCap Growth Index
tracks is computer-driven, S&Ps indexes are
populated by companies chosen by a real, human
committee. And that committee looks for companies with more-seasoned operating track records.
In essence, the S&P indexes built by this committee are actively managed indexes.

FFSA Award Winners


9

Short-Term Investment-Grade had not suffered a


loss over any 6-month or 12-month perioduntil
July 2008 as the financial markets began to falter
and the rush to Treasurys began in earnest. After
setting a new MCL of -7.6% in 2008, the fund
recovered in six months and returned a whopping 14.0% in 2009.

and losses, is still here, joined by a Wellington


Management veteran and a team from Delaware
Investments.

The funds yield remains significantly higher


than Prime Money Markets, enabling it to put
up a 5.2% return in 2010, 1.9% in 2011, and
4.5% in 2012. I credit the steely management of
the fund as much as I do the turn in the markets.
With yields as low as they are today, theres
no question in my mind you should be using a
short-term bond fund, cognizant of the potential
for short-term losses, in lieu of a money market
for your longer-term cash holdings.

Now with a new management lineup, its a brandnew fund, for all intents and purposes. Well have
to see whether thats an improvement or not. Only
time will tell, but Im in no rush to recommend
the new U.S. Growth as theres nothing here that
makes it an outstanding candidate for investment.

Ive been recommending selling this turkey since


early 2001. I thought it might have a shot at
redemption a few years ago. It failed.

More Losers:
STAR LifeStrategy Funds;
Target Retirement Funds

Of course, because some of the income earned


in the government funds is free of state and
local taxes, you might come out slightly ahead
in those funds if you live in a high-tax state. But
if taxes are a big concern, you should probably
be considering a tax-exempt fund like LimitedTerm Tax-Exempt instead.

My Model Portfolios on page 2 of every newsletter issue will guide you to better profits and, in
many cases, less risk than these supposedly simple funds that Vanguard has created for you. For
example, my Conservative Growth Portfolio allocates even less of its assets to stocks yet beats the
pants off of Vanguard STAR LifeStrategy Growth.
Dont be fooled by simplicity. It can mean smaller
profits in your later yearstoo late to do better.

Loser: U.S. Growth


Vanguard uses this fund as one of the holdings
in the STAR fund and recommends it to investors who hire its Financial Planning group to
manage their portfolios. If it werent for that
push from the home front, assets would be flying
out of here even faster than they already are. The
once mighty $22.3 billion fund now has less than
$5 billion in assets.

o there you have it: winning funds that


have stayed ahead of the pack and losers that
fall behind. My Award Winners can be great
investments, but please keep in mind that you
should not just buy them and think youre done.
There are many other good Vanguard funds that
werent mentioned in this report. Plus, even
Award Winners can have bad days. These funds
can add some pop to your portfolio, but its
important to pick funds that fit your investment
style and will provide you with a healthy amount
of diversification.

It took way too long for Vanguard to admit the


errors of its ways, but they finally fired this
funds primary manager, AllianceBernstein, in
October 2010 and reconfigured this decimated
old warhorse as a multimanaged amalgam.
William Blair & Co., which came on in 2004
in an attempt to temper the funds volatility

FFSA Award Winners


10

T H E

I N D E P E N D E N T

ADVISER
for Vanguard Investors

www.AdviserOnline.com

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