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The Active Fund That Defies Obsolescence

Vanguard Wellington is boring and old, but it keeps producing stellar risk-adjusted returns. Here’s how it does it.

Daniel Culloton, 02/12/2013

The strategy of Vanguard Wellington VWELX isn’t supposed to work anymore.

Since 2008’s debacle, many pundits and investors have declared the era of the buy-and-hold, 60%/40% stock/bond portfolio dead. It has become common to hear that the only way to build and preserve wealth is to be more tactical and flit among traditional and alternative asset classes.

This fund stands in quiet defiance of that trend. It continues to deliver competitive results with acceptable risk by keeping things simple and charging a very low fee. In many ways, it is the epitome of a stodgy old fund run by skilled active managers, one on the equity side and one on the fixed-income side.

It buys and holds dividend-paying stocks when the market frowns on them and trims them when they gain favor. Its bond portfolio eschews leverage and derivatives and favors higher-quality corporate bonds with yields that adequately compensate for their risks. The fund’s expense ratio is among the lowest for actively managed moderate-allocation funds, and its managers are seasoned and steeped in and committed to the fund’s approach. It has many desirable qualities.

At nearly $56 billion in assets, it is the fourth-biggest balanced fund in the United States, but its below-average turnover and slightly cross-grained predilections help it manage its girth. Indeed, during 2011’s maddening volatility, equity manager Ed Bousa bought stocks when they were weak and trimmed when they were strong. He took advantage of declines to buy cyclical companies like Ford F and Dow Chemical DOW and to add to positions like Microsoft MSFT. He reduced utility, health-care, and consumer staples stocks that had done well.

As it typically has for years, the fund currently has more in equities than its average moderate-allocation peer, but it hasn’t been riskier. It long-term volatility measures, such as standard deviation, are average to below-average for the peer group, and the fund has delivered investors more return for its risks, according to its 10-year Sortino ratio. There are also a lot of hedge funds that would love to have this fund’s 6% annualized return since Bousa arrived in 2000.

To explore how Vanguard Wellington does it, we will take a deep analytical look at the fund using the five pillars that Morningstar’s analysts use to determine their ratings: Process, Performance, People, Parent, and Price.

This is the oldest balanced fund, and it has seen some strategy shifts and many manager changes in its time. The fund’s current approach, however, has been in place and consistently executed for more than 30 years.

The fund has always tried to balance stocks and bonds, but early on, it was more flexible. It often shifted assets dramatically among equities, preferred stocks, bonds, and cash. That served the fund well for decades until it hit a slump in the mid-1960s and attempted an ill-fated switch to aggressive- growth investing in 1967. In 1978, Vanguard took the fund back to the future by restructuring it into a disciplined, valueoriented hybrid fund that would keep asset allocation between 60% and 70% stocks and 30% and 40% bonds, as well as refocus on the offering’s roots as an investment vehicle that put equal priority on income generation, capital preservation, and capital appreciation.

The managers accomplish these goals in the stock portfolio by seeking out large, dividend paying companies that are competitive and profitable enough to grow their earnings and dividends over time or are poised to improve on those fronts. The fixed-income portion of the fund focuses mostly on investment-grade corporate bonds, though it will own some Treasuries for liquidity and will dabble in agency-issued, mortgage-backed, asset-backed, and municipal securities.

The fund is at the high end of its range for stocks. Bond yields are low—in some cases lower than the dividend yields of blue-chip stocks. So, the managers currently favor stocks.

The fund favors stocks with above-average yields from sectors and industries with favorable supply and demand balances. It has kept a large helping of energy stocks, such as recent addition BP BP. Bousa says that the world’s demand for energy shows no sign of slackening over the long term, but energy sources are harder and more expensive to reach. It has large helpings of health-care and financial companies, though it trimmed some holdings such as Bank of America BAC in the latter sector because Bousa thinks the timing of its rebound has become more uncertain. The fund has favored financially solid companies, selling Nokia NOK while adding to Microsoft.

Bond manager John Keogh has increased the fund’s holdings at the lower end of the investment-grade spectrum that have been out of favor and trimmed positions at the higher end that have done well. But it’s still a high-quality portfolio that owns fewer below-investment-grade bonds than do its peers. The bond portfolio’s duration, a measure of interest-rate sensitivity, is shorter than that of its benchmark, the Barclays Capital U.S. Credit A or Better Index, but longer than that of the broad bond market. So, there is some credit and interest-rate risk here.

Through depressions, expansions, recessions, war, peace, 14 presidents, and a few strategy and manager changes, this fund’s returns have been exemplary. Even with a slump in the 1960s and 1970s, the fund has gained more than 61,000% cumulatively since its July 1929 inception.

Of course, the fund wasn’t always the high-quality, value- and dividend-oriented stock and bond fund it is today. But its record since it codified that approach in 1978 remains impressive.

The fund’s results under the present managers stand out, too. Since Bousa, the longesttenured manager, became the fund’s lead in December 2002, it has gained 116% cumulatively through Dec. 31, compared with 76% for the category average.

Bousa has been a member of the team running this fund since joining Wellington in 2000. He came to the firm from Putnam Investments, where he did a solid job managing Putnam Equity Income PEYAX from late 1992 through early 2000. Bousa also previously worked at Fidelity Investments. He took over the fund in late 2002. Keogh has been the lead fixed-income manager since 2008 but has been with Wellington Management since 1983 and worked as a backup on this fund since 2004.

Wellington’s central bench of equity industry and fixed-income analysts support both Bousa and Keogh as well as their own smaller, dedicated investment teams. Noted Wellington investors such as Karl Bandtel of Vanguard Energy VGENX and Ed Owens of Vanguard Health Care VGHCX also are at Bousa and Keogh’s disposal. Vanguard Dividend Growth VDIGX manager Don Kilbride serves as a backup manager on this fund as well.

Vanguard has become one of the world’s largest money managers by giving fund owners a fair deal and straight talk. Its challenge is not forgetting what got it here.

The source of Vanguard’s competitive advantage and the foundation of its culture is its mutual ownership structure. Shareholders own Vanguard through their funds, which compels the firm to operate at cost, rather than for profit, and put investors’ interests first. It also boasts traits that foster stewardship, such as above-average manager retention, a strong compliance culture, and an independent board.

Vanguard looks out for fund owners in many ways. It shares the economies of its scale via lower fees; has closed actively managed funds when inflows have jeopardized strategies; publishes clear and concise shareholder reports, investing education, commentary, and research; and avoids trendy fund launches.

This is among the cheapest actively managed moderate-allocation funds that retail investors can buy. Its expense ratio is less than a third of the average moderate-allocation fund. The price of its Admiral share class for investors with at least $50,000 to invest is about 8 basis points cheaper. Any way you slice it, this fund is very cheap.

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