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The Once and Future King

Quality, contrarianism, and low cost tilt the odds in investors’ favor with these funds, writes Morningstar's Don Phillips.

Don Phillips, 12/06/2012

This article originally appeared in the December/January 2013 issue of MorningstarAdvisor magazine.  To subscribe, please call 1-800-384-4000. 

In the spring 2008 issue of Morningstar Advisor, in a commentary arguing for simplicity and low cost in building investment portfolios, I posed the question: How many of the sexy asset-allocation or target-risk balanced funds have produced a better result than good old Vanguard Wellington Fund VWELX? My answer at the time—not many—has now been supplemented by nearly five more years of returns, including performance amid the financial meltdown and the Great Recession, the kinds of new-normal crises that presumably demand updated tools like absolute-return strategies if they are to be weathered. So, how did a stodgy, old-fashioned fund like Wellington fare in the face of these modern ills? It currently places in the top 6% of the moderate allocation category for the trailing five years.

The enduring superiority of Vanguard Wellington reminds us all to be leery of it’s-different-this-time promises and to embrace the timeless benefits of a high-quality bias, a moderately contrarian bent (the hallmark of a balanced strategy), and low costs. So, before the next round of second guessing on Wellington begins—and trust me, it will happen—let’s go back a few years to recall how compelling the case against Wellington’s strategy seemed in the depths of the 2008/early-2009 bear market.

Wellington lost more than 22% in calendar 2008, and it continued to post losses in early 2009. While it had less financial services exposure than other large-value stock managers, its yield-oriented strategy and its bond exposure weren’t enough to keep the fund in the black. Critics noted that its long bond position could be vulnerable to future rises in interest rates and that its conser- vative equity exposure didn’t give it much exposure to areas like emerging markets that suddenly looked healthier than the United States and Europe. Most significantly, the fund’s critics argued, Wellington was playing yesterday’s game. Its long-only investment approach simply wasn’t made for these more volatile times and the needs of today’s retirees and near-retirees.

The fund industry’s marketing wizards sprang into action. The most ballyhooed fund launch of early 2009 was a series of absolute-return funds that promised target levels of return in excess of inflation. One of the funds was specifically targeted as an updated version of a balanced fund, but one that wasn’t restricted to blue-chip stocks and investment-grade bonds—and most importantly, one that could short securities in addition to going long, thus promising steadier results than a fund like Wellington, which was then sporting double- digit losses for the trailing 12 months.

In a time of sharp withdrawals in the industry as a whole, these much-talked-about funds brought in billions of dollars in new assets and seemed to promise a path for active management. An industry newsletter named the firm’s CEO Fund Leader of the Year, and he was hailed as a visionary, even though objectively the funds were marked by high costs, high turnover, and opaque strategies—the polar opposite of Wellington. So, how did the future of active management fare? Over the trailing three years, the A shares version of this “balanced” absolute- return fund has gained an annualized 4.44%, ranking in the 92nd percentile of its category. Vanguard Wellington sports an annualized trailing three-year return of 10.5% and ranks in the 16th percentile of its category.

Most challengers to Wellington’s throne fail because in their excitement to innovate they miss the keys to its success—quality, contrarianism, and low fees. One notable exception is Rob Arnott’s PIMCO All Asset Fund PASAX, a globally diversified portfolio of other PIMCO funds. It has fared slightly better than Wellington over the past five years, even though its soon-to-be-achieved 10-year record will likely trail Wellington’s because of bum years in 2003 and 2006. What PIMCO got right was to keep costs relatively low, to build from an outstanding roster of institutional- quality funds, and to have a brilliant student of market history with a disciplined, contrarian bent in Arnott at the helm.

Even as it embraces more complex techniques and casts a wider investment net, PIMCO All Asset stays true to many of the same virtues that have defined Wellington’s success. Quality, contrarianism, and low cost tilt the odds in investors’ favor with both funds. So, if you feel that you must stray from the master, at least be sure you’re going with a fund that comes from a similar heritage even though it tries to forge a slightly different path. Both Vanguard Wellington and PIMCO All Asset are Morningstar Medalists with a Gold Analyst Rating. The balanced absolute-return fund discussed above is not yet graded by our analysts, but currently earns a 1-star rating.


Don Phillips is a managing director of Morningstar, Inc.

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