Tue, 15 Jan 2013
Although some Vanguard funds underperformed their peers during the market rally, the firm had more portfolios in the top quartile of their categories than in the bottom quartile.
Christine Benz: Hi, I am Christine Benz for Morningstar.com. The year 2012 lifted many boats, and Vanguard funds were no exception. Joining me to share some performance highlights of the firm is Bridget Hughes. She is associate director of fund analysis for Morningstar.
Bridget, thank you so much for being here.
Bridget Hughes: No problem, thank you, Christine.
Benz: When you look at sort of a headline for Vanguard funds for 2012, what would you say it is, Bridget?
Hughes: Well, I mean as you mentioned, it was a market that lifted many boats, and Vanguard was lucky to be with the tide there. So, there isn't a lot of red ink at Vanguard, though there is a little bit. But what I would say about it is that more of its funds did better than they did worse, so there were more funds in the top quartile, if we're looking at category rankings versus peers, than there were in the bottom quartile.
Benz: Let's drill into some specific asset classes, starting with domestic equities. When you think about some of the firm's biggest winners for last year, what are the funds that jump to mind?
Hughes: So, a couple of them jump to mind. There is Vanguard Windsor, and then there is Vanguard Capital Value. These funds shouldn't really surprise anybody who's been a shareholder that they're at the top of the heap in 2012. I mean they are kind of more aggressive, typically higher-beta, higher-volatility funds, typically with some economic sensitivity in there. Financials were a big part of the story for those funds, and so those kind of spring to mind, both of them with bigger than 20% gains and at the top of the group for Vanguard.
One thing I want to mention about Vanguard Windsor that everybody should always take into account when they're evaluating mutual funds is that there was a manager change in August. This isn't a huge deal I don't think in terms of its performance because Wellington Management, which has been a longtime manager there, continued to run 70% of the portfolio. So really it was a big driver of the returns in 2012.
But the new manager, Pzena Investment Management which also runs John Hancock Classic Value, is a similarly aggressive type of portfolio manager. It will be a little bit more concentrated going forward. So, just because there was a manager change, I wouldn't have investors expect that there is going to be any moderation in the volatility for that fund.
Benz: So, there's still high-beta, sort of higher-risk investments [for the fund]?
Benz: It sounds like at the other end of the spectrum, the funds that didn't fare so well in relative terms, though they did fine in absolute terms, were funds that were sort of dividend-centric, quality-centric, let's talk about one or two of those.
Hughes: Exactly. Vanguard Dividend Growth, which was one of Vanguard's funds that attracted a lot of assets in 2012, actually didn't perform that well on a relative basis. Now, it still gained more than 10%, but in a market where the S&P was up 16%, that maybe doesn't look so good. But what's important to remember about this cache of these dividend funds, these yield-oriented funds, these income-oriented funds, is that they are intended to be more conservative investments.
So, in a rally like we had in 2012, they're going to look a little bit sluggish. But that's part of their charm because what they do best is that they hold up better in the down markets, and that allows them to keep compounding that wealth. And they just sort of are more long-term-oriented and they let the dividend income and maybe a little bit slower growth compound that wealth for them over time.
Benz: Another of the funds that didn't do so well in relative terms, another very big fund is the specialized fund, Vanguard Health Care, which didn't have its best year. What was going on there?
Hughes: Right. And again it was up 15%, so who can really complain? But that's a fund that for many, many years has had a big chunk of its assets in Big Pharma, and that just wasn't the most exciting place in 2012. So it's very limited in terms of its biotech exposure and maybe some of the other more services and diagnostics areas, and that's not likely to change. Now, Ed Owens, who had run the portfolio for decades, just retired at the end of 2012.
But I would expect that Wellington, which will continue to run the portfolio, will keep that large-cap pharma bias. First of all, the fund is just huge. Its [portfolio value is] $23 billion or something like that. So, it's limited in terms of what kind of biotech exposure it can really have when a lot of those companies are very, very small.
Benz: Now, I want to focus on international, as well, and you wanted to focus on a couple of specific names, at opposite ends of the value-to-growth spectrum. Let's talk about what those funds are and how they performed exceptionally well last year.
Hughes: So, the international side is a little bit smaller for Vanguard than the U.S. side, but nonetheless, it does have a number of very large funds. The two that jumped out at me were Vanguard International Value and Vanguard International Growth, and they really are a value fund and a very growth-oriented fund. So they look very differently when you look their portfolio metrics in terms of P/E ratios and historical growth rates and that sort of thing. There is a little bit of overlap.
What was interesting to me is that they both returned 20.18% for 2012, so you are getting exactly the same return down to a 100th of a percent and yet doing it in very different ways. They do both have more exposure to emerging markets than their respective peers, so that is a little bit of a common ground that they share. They are both, like Vanguard does with many of its actively managed funds, subadvised by multiple subadvisors, and Vanguard tries to pick complementary subadvisors.
So, it was just interesting to me that they kind of went different ways but came out with the same return, and what I guess was a comment to me was that that there wasn't a lot of disparity in terms of value versus growth, that, again, the market lifting all boats kind of worked on the international waters, as well.
Benz: Both those funds are doing very well. And just in interest of disclosure, I'll say that I have them both, and I'm happy to hear that they did so well. Let's talk about fixed income a little bit, Bridget. A lot of the firm's money is indexed. How did Vanguard Total Bond Market Index, that is sort of their bread-and-butter product, do relative to its intermediate-term bond peer group?
Hughes: Well, not so well, compared with the peer group. A lot of the fixed-income returns that we saw last year were meager, really, compared with other years when maybe there is a flight to quality or there is a flight to safety. But we're talking about single-digit returns, and that maybe is a reflection of the fact that there are very low yields out there. So even though the big Vanguard funds performed kind of poorly compared with their peer groups, they still have the advantages of the very low expense ratios, which especially in a low-return environment can make a very big difference over the long term.
Benz: In terms of very good performance on the fixed-income side, one that you flagged is Vanguard High-Yield Tax Exempt. What's the story there?
Hughes: So, the High-Yield Tax Exempt fund is a fund that returned just under 10%, which is pretty good.
Benz: For a bond investment.
Hughes: For a bond fund, right and tax-exempt, as well.
Hughes: But what's interesting about this particular fund is that we put it in the muni national intermediate-term category. It has High Yield in its name; it does own high yield. Its Vanguard's version of a high-yield tax exempt fund, but it is very conservative in how much high yield that it'll own. So it owns only up to 25%, currently somewhere around 20%. And that puts it in a category of a more general higher-quality fund. So it stands out in that category. And because of that, even that 20% in high yield, it really performed well as higher-yielding securities performed well. If you put it in the other category, it wouldn't look as good.
Benz: The last thing I would like to cover with you, Bridget, is how some of the big core equity index funds did last year. You've touched on a lot of the active products. How about, say, Vanguard Total Stock Market and the 500 Index trackers. How did they do versus their large-cap blend peer group?
Hughes: Well, I would say that, first of all if we had a video about Vanguard and didn't mention the big index funds, people might scratch their heads and wonder what kind of a fund company we're talking about. I mean, the big S&P 500 fund that Vanguard runs has more than $110 billion in assets, so it's definitely worth touching on. And it did what it was supposed to do. It returned about 16%. It landed in the top third of its category. The Total Stock Market Index fund was a little bit better because it had some smaller-cap stocks, and those performed better generally.
Benz: Bridget, thank you so much for the recap. It's been really helpful.
Hughes: Sure. Thank you.
Benz: Thanks for watching. I am Christine Benz for Morningstar.com.