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All Contents © 2019The Kiplinger Washington Editors
By Nellie S. Huang, Senior Associate Editor
| November 8, 2017
Index funds have made Vanguard a 401(k) behemoth. A total of 33 Vanguard funds rank among the 100 largest funds in 401(k) assets, according to consulting firm BrightScope. Of those funds, 14 track market benchmarks, such as Standard & Poor’s 500-stock index (including Vanguard Institutional Index, the largest 401(k) fund in the country). Another eight are Vanguard Target Retirement funds: blends of stocks and bonds that mirror market bogeys.
Yet Vanguard doesn’t just dominate with index funds. The firm has a stable of 11 actively managed funds that also rank among the 100 most popular 401(k) funds in the country.
We analyze each of these actively managed funds, rating them “buy,” “sell” or “hold.” Some of these funds may be available through lower-cost share classes in your 401(k). Returns and data are as of Oct. 31; three- and five-year returns are annualized.
Expense ratio: 0.45%
One-year return: 34.1%
Three-year return: 13.6%
Five-year return: 20.6%
Value of $10,000 invested 10 years ago: $24,846
Top three holdings: Biogen (BIIB), Amgen (AMGN), Eli Lilly (LLY)
If your 401(k) offers this fund, it’s time to do your happy dance. Capital Opportunity is closed to new investors outside of workplace retirement plans. But anyone can buy the shares through a 401(k), and we highly recommend it.
The fund is a superstar. Annualized returns have averaged 14.2% a year since February 1998, when Vanguard handed the reins to subadviser Primecap Management. By contrast, the S&P 500 returned about half that, averaging 7.0% a year over the same period.
Primecap’s method of picking stocks is a closely guarded secret. When we tried to interview its fund managers for a 2015 article, we couldn’t get past the receptionist, who told us that she had been instructed not to pass along messages from reporters.
But we can tell you a few things about this fund. It’s run by five investing veterans: Theo Kolokotrones, Joel Fried, Alfred Mordecai, M. Mohsin Ansari and James Marchetti. Each one handles a slice of the portfolio, investing in growing companies of all sizes. They look for stocks trading at bargain prices, and they aim to identify a catalyst—a new product or corporate restructuring—that they think will push a stock higher over the next three to five years.
One caveat with this fund is that it tends to be more volatile than the broad market. But investors are being rewarded for taking the risk. Over the past 11 calendar years, including so far in 2017, Capital Opportunity has outpaced the S&P 500 seven times.
Buy this fund if it’s available, and hold on for long-term growth.
Expense ratio: 0.26%
One-year return: 20.8%
Three-year return: 10.1%
Five-year return: 13.9%
Value of $10,000 invested 10 years ago: $21,206
Top three stock holdings: Microsoft (MSFT), JPMorgan Chase (JPM), Philip Morris International (PM)
Equity-Income is a member of the Kiplinger 25, the list of our favorite no-load funds. We think it’s a solid choice for investors who want a conservatively managed large-company stock fund with an above-average yield. The fund recently yielded 2.7%, compared with 2% for the S&P 500.
Wellington Management’s Michael Reckmeyer manages two-thirds of the fund’s assets, investing in large firms with above-average yields. He also looks for companies with good growth prospects and the financial muscle to raise their payouts steadily. Vanguard’s quantitative group, using computers to pick stocks, runs the rest of the fund, homing in on large, high-quality firms with attractive yields.
Since August 2007, when Reckmeyer and the quants took over, Equity-Income has returned an annualized 8.5%, edging the S&P 500 by an average of 0.1 percentage point per year. That isn’t impressive. But the fund has been about 5% less volatile than the market over that period, giving investors a smoother ride.
If you who want exposure to large U.S. stocks with a robust dividend yield, then this fund is for you.
Expense ratio: 0.46%
One-year return: 27.1%
Three-year return: 9.0%
Five-year return: 14.9%
Value of $10,000 invested 10 years ago: $20,745
Top three holdings: Cadence Design Systems (CDNS), Icon Public Limited (ICLR), Insulet (PODD)
Figuring out who runs Explorer—a small-company growth fund—isn’t easy. The fund is one of many that Vanguard farms out to external advisers. A revolving door of managers has shuffled through Explorer over the past 10 years, and the number of shifts is troubling.
What’s more, we think the fund is too big. With $12.8 billion in assets, Explorer is the third-largest small-cap fund in the country. Investing nimbly in small companies isn’t easy for a fund this big.
So what does Explorer have going for it? For starters, its expense ratio of 0.46% is 66% lower than that of other actively managed small-cap funds, according to Morningstar. Low fees should help Explorer at least keep pace with the small-cap market.
The fund’s recent performance is encouraging, too. Through the first nine months of 2017, Explorer’s 16.0% return outpaced the Russell 2000 small-cap index by 5.1 percentage points.
Although we aren’t thrilled with the shifting slate of managers, we think Explorer deserves a “hold” (up from a “sell” last year). The fund may not beat its bogey by much, but you won’t pay hefty fees to take a shot.
Expense ratio: 0.20%
One-year return: -0.4
Three-year return: 1.3
Five-year return: -0.3
Value of $10,000 invested 10 years ago: $14,178
We don’t have any qualms about the manager of this fund, Gemma Wright-Casparius. Since taking over in 2011, she has delivered a 1.0% annualized return, beating the 0.7% return of the average fund in this category.
But we’re slapping a “sell” on this fund because of its investment focus: Treasury Inflation Protected Securities. TIPS are government bonds that gain value when inflation is rising (or investors expect it to pick up). Yet inflation has remained stubbornly low and expectations for inflation aren’t budging much either. Federal Reserve Chairman Janet Yellen recently called the lack of inflation, despite strength in the economy, a “mystery,” hardly inspiring confidence in TIPS.
We think you can do better in a fund that holds standard Treasuries or other high-quality bonds. Vanguard Intermediate-Term Treasury (VFITX), for instance, recently yielded 1.8%, well above the 0.1% yield of this fund. The inflation rate would have to pick up substantially for a TIPS fund to pay off, and we aren’t seeing signs of that now.
One-year return: 35.2%
Three-year return: 11.2%
Five-year return: 11.8%
Value of $10,000 invested 10 years ago: $14,582
Top three holdings: Tencent Holdings (TCEHY), Alibaba Group (BABA), Baidu (BIDU)
Although Vanguard’s name is on this foreign stock fund, it’s run by two external managers: Investment firm Baillie Gifford handles 60% of its assets, and subadviser Schroders runs the rest. We think that’s a reasonable arrangement for a fund with more than $31 billion in assets (making it the fifth-largest actively managed large-cap foreign stock fund in the country).
The fund has been sizzling lately, returning 40.5% so far in 2017, beating 95% of its rivals. Hot Chinese internet stocks such as Alibaba Group and Tencent Holdings, along with Hong Kong-based insurer AIA (AAIGF), have helped turbocharge returns. The fund also keeps about 9% in U.S. stocks that have fared exceptionally well, including Amazon.com (AMZN), Illumina (ILMN) and Tesla (TSLA).
A risk with this fund is that its high-growth style and exposure to emerging markets (23% of assets) could quickly fall out of favor. The fund has been riskier than its peers over the past decade, and its volatility is now on the high side, compared with the average foreign growth fund.
Buy this fund to participate in the growth of foreign economies and companies. But strap in for a potentially rocky ride.
Expense ratio: 0.38%
One-year return: 29.5%
Three-year return: 12.5%
Five-year return: 16.5%
Value of $10,000 invested 10 years ago: $21,154
Top three holdings: Apple (AAPL), Alphabet (GOOGL), Microsoft (MSFT)
The “Morgan” in this fund’s name refers to Walter L. Morgan, who founded Wellington Management, the firm that runs many actively managed funds for Vanguard. Wellington is best known for its value-investing style. But Morgan is an exception: The fund homes in on large companies with strong sales and profit growth, with much less concern paid to a stock’s price.
The strategy is paying off handsomely these days. At last report, more than 40% of Morgan’s assets were in sizzling technology stocks, such as Alibaba Group (BABA), Alphabet (GOOGL), Amazon (AMZN) and Facebook (FB). These types of stocks have helped fuel the fund’s 26.6% return this year, crushing the 16.9% gain of the S&P 500. Morgan’s hot streak doesn’t appear to be an anomaly either. The fund has outpaced the S&P 500 in all but five of the past 11 calendar years.
Our concern with Morgan is that it could suffer if a handful of high-growth tech stocks start to falter. The fund’s managers would have to act fast to avoid losses in that scenario, and that won’t be easy for a fund with $13 billion in assets.
Nonetheless, we think this is a good bet in the current growth-oriented climate. Stick with it for the long term and you probably won’t be disappointed.
Expense ratio: 0.39%
One-year return: 30.9%
Three-year return: 13.1%
Five-year return: 19.3%
Value of $10,000 invested 10 years ago: $26,046
Top three holdings: Biogen (BIIB), Alphabet (GOOGL), Eli Lilly (LLY)
All the talk about active managers lagging index funds doesn’t apply to Vanguard Primecap. Over the past 10 years, the fund’s 10.1% annualized return beat the S&P 500 by more than 2.6 percentage points per year. Hardly any other large-cap funds have achieved that feat, landing Primecap in the top 6% of its peers.
As we mentioned earlier, Primecap’s five Los Angeles–based managers are mysterious. Managers Theo Kolokotrones, Joel Fried, Alfred Mordecai, M. Mohsin Ansari and James Marchetti rarely talk publicly about how they pick stocks or what they like these days.
What we can tell you is that the fund holds an eclectic mix of large-cap growth stocks, emphasizing health care companies, industrial firms and technology stocks. The managers also tend to buy and hold: Primecap’s turnover ratio is just 6%, implying that stocks in the portfolio typically stay for more than 15 years. FedEx (FDX) and Medtronic (MDT), for instance, have been in the fund since 1986.
If your 401(k) offers this fund, buy it and consider yourself lucky. The fund is closed to new investors outside of workplace retirement plans (though you can buy a similar fund, Primecap Odyssey Growth (POGRX), which is a member of the Kiplinger 25).
Expense ratio: 0.22%
One-year return: 8.5%
Three-year return: 6.1%
Five-year return: 7.0%
Value of $10,000 invested 10 years ago: $19,321
Top three holdings: Microsoft (MSFT), JPMorgan Chase (JPM) and Philip Morris International (PM)
Conservative investors should appreciate Wellesley Income. The fund consistently holds about 60% of its assets in bonds and 40% in stocks, making it a solid choice if you’re willing to give up some growth in exchange for stability and income. The fund recently yielded 2.7%, well above the 2% payout of the S&P 500.
Manager Michael Reckmeyer picks the stocks, focusing on dividend payers that appear out of favor. Bond managers John Keogh, Loren Moran and Michael Stack emphasize high-quality corporate debt, focusing mainly on short- and intermediate-term IOUs.
The fund’s investing style has produced stable, moderate gains. Returns have been positive in 10 of the past 11 calendar years. The fund lost 9.8% in 2008, but that was far better than the -18.6% average return for its peer group (funds that invest 30% to 50% in stocks). Over the past decade, Wellesley Income’s 6.8% annualized return beat 96% of its rivals.
One caveat: The fund’s bond holdings have an average duration of 6.5 years. That means bonds in the portfolio would fall in price by 6.5% if interest rates were to increase by a percentage point. We don’t expect rates to rise sharply over the next year. But if they do, Wellesley Income could suffer.
Expense ratio: 0.25%
One-year return: 16.2%
Three-year return: 7.9%
Five-year return: 10.4%
Value of $10,000 invested 10 years ago: $19,634
Top three holdings: Microsoft (MSFT), JPMorgan Chase (JPM), Chevron (CVX)
Founded in 1929, Wellington is America’s oldest balanced fund, and it remains true to its original goal: to provide growth and income with a mix of 65% in stocks and 35% in bonds.
We have long been fans of this fund, which is in the Kiplinger 25 (the list of our favorite no-load mutual funds). Annualized returns have been superb, averaging 9.1% over the past 15 years, beating the category average of 7.9% and pushing Wellington into the top 6% of its peer group.
Funds that hold a mix of stocks and bonds aren’t likely to keep up with pure stock funds during bull markets. Wellington is no exception: Its annualized return has trailed the S&P 500 by nearly five percentage points over the past five years.
Yet Wellington’s conservative style will pay off if the stock market stumbles. Run by subadviser Wellington Management, the fund sticks with high-quality stocks and bonds. Manager Edward Bousa, who picks the stocks, focuses on large companies that pay dividends in areas such as health care and financial services.
On the bond side, John Keogh, Loren Moran and Michael Stack buy mostly high-grade corporate and government debt. Those types of bonds don’t yield much these days. But they will help keep the fund steady in a stock market downturn. Overall, the fund yields 2.3%.
Buy this fund if you want to balance the volatility of stocks with the stability of bonds.
Expense ratio: 0.30%
One-year return: 24.5%
Three-year return: 8.7%
Five-year return: 14.6%
Value of $10,000 invested 10 years ago: $18,387
Top three holdings: Citigroup (C), Bank of America (MSFT), Bristol-Myers Squibb (BMY)
At a glance, Windsor’s performance looks weak. The fund is trailing the S&P 500 this year. And Windsor has lagged the market over the past three-, five- and 10-year periods on an annualized basis.
Yet Windsor is a value fund: It focuses on large-company stocks trading at bargain prices relative to the market or their industry. Investors have favored growth stocks over value for years, making it tough for funds like Windsor to get ahead.
We can’t predict whether value stocks will start to break out. But if they do, Windsor should be a winner. The fund’s subadvisers—Wellington Management and Pzena Investment Management—each look for value stocks in a slightly different way. Wellington manager Jim Mordy hunts for companies in out-of-favor sectors such as energy, looking for firms that should be able to lift their earnings back to a normal level. Pzena’s Richard Pzena fishes for the lowest-price stocks on the market, based on historical earnings valuations.
Vanguard doesn’t break down the performance contribution of each firm. But since the two came together at Windsor in 2012, they have edged the typical large-cap value fund by an average of 2.2 percentage points per year. That’s good enough for us to recommend holding this fund.
Expense ratio: 0.33%
One-year return: 19.6%
Three-year return: 7.7%
Five-year return: 12.5%
Value of $10,000 invested 10 years ago: $17,625
Top three holdings: Microsoft (MSFT), Citigroup (C), Pfizer (PFE)
Windsor’s problem is simple: Too many cooks are spoiling the stew. Vanguard outsources the fund to five subadvisers who each use their own methods to try to find cheap stocks. Vanguard gets involved, too, relying on computer models to pick stocks, though it only oversees 1% of the fund’s assets.
The result: a watered-down fund that hasn’t distinguished itself. Returns have been mediocre for years, compared with other large-cap value funds. Over the past decade, the fund has trailed 50% of its peers on an annualized basis. Worse, it has lagged the S&P 500 by an average of 1.7 percentage points a year during that time frame.
If you want a large-cap value fund in your 401(k), go for Vanguard Windsor (VWNDX).
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