How Have Vanguard's Best Bear-Market Funds Done?

Late in the summer of 2007, after a sell-off in June and July gave us the first taste of what 2008 has had in store for us, I highlighted in an article on Morningstar.com what I thought were Vanguard's best bear-market funds. I'm not bragging. I made it clear in the article that I wasn't predicting a bear market, just trying to point investors who got a bad case of the jitters after last year's volatility toward some options that might be easier for them to hold over the long term. A secondary purpose was to single out offerings that might achieve some of the same goals of the new  Vanguard Market Neutral (VMNFX)--downside protection and decent absolute returns--without the short selling or extra expense.

Just how have those funds fared since the big bad bear came out to play this year? And how have they done relative to the new Vanguard Market Neutral? Well, the good news is that all of the five funds I mentioned have done better than their respective peers in the past year. The bad news is that four of the five have suffered losses that would stress the most optimistic investor's definition of downside protection. It's been that kind of a year. Even funds that have performed as designed are down double digits. Here's a look at the funds.

You Should See the Other Guy
 Vanguard LifeStrategy Income (VASIX) has lost more than 12% for the year ended in October, but that was less than about 90% of the conservative-allocation category. The fund of funds lost money despite keeping nearly three fourths of its assets in  Vanguard Short-Term Investment Grade (VFSTX) and  Vanguard Total Bond Market Index (VBMFX)--two diversified fixed-income funds with better-than-average credit quality and less interest-rate risk relative to their respective peers. There have been few places to hide this year, but the fund also has taken a hit from its position in  Vanguard Asset Allocation . Asset Allocation, a fund that can shift its helping of stocks, bonds, and cash depending on its projections for their future returns, has been mostly in stocks for most of this year, which has hurt.

 Vanguard Wellesley Income (VWINX) has lost a little bit more. It's down about 13% in the year through the end of October, still better than 86% of the conservative-allocation category. Though the conservative portfolio of high-yield stocks and investment-grade corporate bonds has held up relatively well, it has not dodged every bullet. The fund nibbled at  Citigroup (C) and  Fannie Mae (FNM) in the first half of the year when the managers thought the stocks' yields and prices began to offer margins of safety for their risks. The fund, however, has still lost less than you would expect for an offering with a large financial sector stake and big helping of corporate bonds.

All Things in Moderate Allocation
The good thing about  Vanguard Balanced Index (VBINX) for long-term investors was a bad thing over the past year. The fund gives you the average return of the stock and bond markets, minus a low expense ratio, in a roughly 60%/40% equity/bond split. That cheap, low-maintenance portfolio usually has been enough to put the fund ahead of its typical peer, and it has over the past year. But if both stocks and bonds are falling, this fund doesn't offer much protection from absolute losses. It shed more than a fifth of its value for the year through Oct. 31. It could be worse, though. The fund's results are still better than 88% of its moderate-allocation peers.

 Vanguard Wellington (VWELX) has been better than four fifths of its moderate-allocation peers, but it still lost 24% for the year through the end of October. Like its sibling, Wellesley Income, it did many things right, including being underweight in financial stocks in its equity portfolio coming into this year. But it didn't do everything right. For example, it didn't trim fast enough an overweighting in energy companies, which crashed with oil prices this fall, and it waded back into some financials too early. Still the fund has done very well relative to peers, considering it has larger-than-average stakes in stocks and corporate bonds, which have also been hit hard.

Stuck in Neutral
 Vanguard Short-Term Tax-Exempt (VWSTX) has been the safest port in this storm, so far. It gained more than 2.7%, better than 97% of its peers thanks to a higher-quality, shorter-duration portfolio relative to its short-term muni peers. That cautious profile has paid off lately because the market's turmoil has taken a heavier toll on lower-quality and longer-maturity bonds. This fund has proven it offers sound shelter for money you need soon. It still won't protect the money you don't need for a decade or so from the ravages of inflation, though.

Vanguard Market Neutral isn't really an alternative to any of these options. It doesn't purport to be a one-stop portfolio, and it's not a fixed-income fund. But the fund that strives for consistent, modest absolute returns with low volatility by taking long and short positions in stocks was the fund that got me thinking about Vanguard funds and bear markets in the first place. Its has lost less than all the funds from above with equity exposure, shedding about 6% for the year through the end of October. That looks relatively competitive until you consider that losing money isn't really neutral and the results don't clear the fund's own performance hurdle: the three-month Treasury Bill. The Merrill Lynch Treasury Bill 3 Month Index has gained 2.7% in that time, while an exchanged-traded fund that tries to track that short end of the Treasury yield curve, the SPDR Lehman 1-3 Month T-Bill (BIL), gained nearly 2%. Over a longer period Market Neutral still may achieve its goal, but it hasn't so far in this bear market.

		Vanguard Fund Family Report
	Our new eight-page report gives you independent Morningstar opinion and information on these fund families each month.		It includes news, in-depth analysis on what it means for you, the best and worst funds in a family, and much more. Learn more.
	$99.00 for 12 issues