Assessing Vanguard's Big Roster of Allocation Funds

Investors who are seeking exposure to U.S. stocks and bonds in a single mutual fund have more than 500 choices across the three domestic-allocation categories. While these three categories have their shares of subpar and so-so offerings--as all groups do--they also include dozens of superior options from across the risk/reward spectrum. But investors have exhibited a pronounced bias toward tame hybrid offerings over the past few quarters. Over the 12 months through Sept. 30, the conservative-allocation category has seen $11.1 billion in inflows, while the moderate-allocation group has seen $13.6 billion in outflows and the relatively new and fairly small aggressive-allocation group has seen $1.9 billion in outflows. (Data includes funds of funds.)

At the same time, Vanguard has one of the biggest and best rosters of domestic-allocation funds around. And the firm recently announced important changes at several of these funds. (The board of trustees for the four Vanguard LifeStrategy funds and Vanguard STAR has approved adjustments to their asset mixes--including larger foreign-equity weightings at all five offerings--and Vanguard STAR just changed its subadvisor lineup.) Therefore, we thought it would be worthwhile to review the strategies, merits, and cash flows of each of the family's 10 domestic-allocation offerings.

Keep Life Fairly Simple
The four funds of funds in the Vanguard LifeStrategy series-- Vanguard LifeStrategy Income (VASIX),  Vanguard LifeStrategy Conservative Growth (VSCGX),  Vanguard LifeStrategy Moderate Growth (VSMGX), and  Vanguard LifeStrategy Growth (VASGX)--have several positive features. For starters, Vanguard doesn't tack an extra layer of fees onto its fund of funds, and all of the underlying holdings have low expense ratios, so these funds rank among the cheapest allocation offerings around. They're exceptionally diversified, because they divide their assets among a set of wide-ranging, index-oriented equity, bond, and hybrid offerings, including  Vanguard Total Stock Market Index (VTSMX) (which provides exposure to 3,400 equities from across the market-cap, style, and sector spectrums) and  Vanguard Total Bond Market Index (VBMFX) (which tracks the Barclays Capital U.S. Aggregate Float Adjusted Index, a broad proxy for the investment-grade U.S. bond market). And the LifeStrategy funds' weightings in those two offerings as well as their overall compositions are consistent with their objectives.

Thanks to their big cost advantages, the success of their underlying offerings, and the benefits of their compositions, the LifeStrategy funds have posted good results and delivered on their goals over time. LifeStrategy Income has gained more than the conservative-allocation average over the trailing 10- and 15-year periods, for example, while holding up relatively well in stock sell-offs, suffering less volatility than the group norm, and paying out a healthy yield.

Meanwhile, each fund is slated to have smaller weightings in Vanguard Total Stock Market Index and the hybrid offering along with a slightly larger allocation in Vanguard Total Bond Market Index and a significantly bigger stake in  Vanguard Total International Stock Index (VGTSX). These composition changes make sense given the growing importance of overseas stock markets--and they will make these funds even more diversified--so they're positive developments.

The flows for these four funds have been in line with investors' preferences for tamer domestic-allocation offerings. LifeStrategy Income and LifeStrategy Conservative Growth have experienced inflows over the past years, whereas LifeStrategy Moderate Growth and LifeStrategy Growth have suffered outflows.

Reserved and Distinctive
Vanguard has two dirt-cheap conservative-allocation funds that stand out from the category crowd.  Vanguard Tax-Managed Balanced (VTMFX) keeps 45% or so of its assets in stocks and spreads that stake across 500 or 600 of the lower-yielding names in the Russell 1000 Index, while most of its peers devote around one third of assets to stocks and employ more-concentrated stock-selection strategies. Its fixed-income portfolio is filled with hundreds of intermediate-term, high-quality municipal issues, whereas the majority of its rivals own a mix of Treasury, mortgage, and corporate bonds. And it provides no direct overseas exposure, while most of its peers invest about 10% of their assets abroad. This fund is in the hands of two seasoned and skilled managers who have executed its strategy well, so its long-term tax-adjusted record is attractive. It's an excellent choice for those seeking a tame, tax-sensitive offering. Investors seem somewhat underwhelmed, though. This fund has seen modest outflows over the past year and only has around $710 million in assets.

 Vanguard Wellesley Income (VWINX) has a fairly typical composition for a conservative-allocation offering. But equity manager W. Michael Reckmeyer III is a yield-oriented contrarian who usually holds 50 to 60 names and readily buys stocks in bunches, so this fund's sector weights often differ significantly from the category averages. And bond skipper John Keogh tends to pay more attention to corporate credits and maintain a longer duration than most of his counterparts, so this fund's fixed-income stake is distinctive as well. These atypical stock and bond strategies come with risks, but Reckmeyer and Keogh have handled them well--as did their predecessors--and this fund has handily outpaced most of its rivals over time while paying out a superior yield. Investors have continued to appreciate this fund's many qualities: It has attracted $2.4 billion in assets over the past 12 months, and it's the second-largest conservative-allocation offering, with $18 billion in assets.

Pretty Simple to Fairly Complicated
Vanguard has four attractively priced moderate-allocation funds that vary widely in terms of the complexity of their strategies.  Vanguard Balanced (VBINX) takes a plain-vanilla approach. It maintains a 60%/40% split between stocks and bonds, which is in line with the group norm. It tracks the MSCI U.S. Broad Market Index with its equity stake and the Barclays U.S. Aggregate Bond Index with its fixed-income position, so it provides quite diversified and rather mainstream stock and bond exposure. And thanks to Vanguard's indexing prowess as well as the fund's low expense ratio, it has delivered fetching returns with moderate volatility over the long run. This fund should please indexing fans who want straightforward exposure to the U.S. stock and bond markets. It has lost $98 million in outflows over the past year, but it still has nearly $9.5 billion in assets.

The managers of  Vanguard Asset Allocation  set its asset mix based on a model that assesses the relative attractiveness of stocks, bonds and cash, and they regularly make decisive composition calls. Once they set the composition, they take a passive approach, mirroring the S&P 500 Index with their stock position and the Barclays Capital Long-Term Treasury Index with their bond portfolio. The managers have earned good results with this approach thus far in 2010 and over the trailing 15-year period. But it's tough to consistently hit the mark with composition calls, and errant ones can really backfire, as this fund's high level of volatility and poor results in both 2008 and 2009 make clear. Although this fund does have merit for investors who want an asset-allocation vehicle for the long haul, it has suffered $648 million in outflows over the past 12 months, which is roughly 7% of the assets it had under management on Sept. 30, 2009.

 Vanguard Wellington (VWELX) sticks pretty close to a 65%/35% split between stocks and bonds, which is a bit more equity exposure than the moderate-allocation norm. Ed Bousa favors big firms with modest valuations, solid dividends, and improving fundamentals, and he goes wherever the best opportunities are, so the equity portfolio tends to have a huge average market cap and sizable stakes in yield-rich sectors. John Keogh favors corporate credits and maintains a relatively long duration here, too. Bousa and Keogh have executed this straightforward approach skillfully in a variety of climates--and their predecessors accomplished the same. Indeed, the fund boasts an exceptional long-term record. It remains one of the best hybrid offerings around, and investors continue to notice. It has had approximately $1.1 billion in inflows since Sept. 30, 2009, and now has more than $50 billion in assets.

 Vanguard STAR (VGSTX) would do Baskin-Robbins proud. This fund of funds divides its fixed-income among three offerings: a short-term bond fund that focuses on corporates but can also invest in other bonds, an intermediate-term bond fund that emphasizes GNMA pass-throughs, and a long-term bond offering that favors high-quality corporates but also owns government securities. It spreads its domestic-stock position across six actively managed offerings that span the market-cap and style spectrums, while it splits its foreign-equity stake between a pair of actively run foreign large-cap funds. And five of its six domestic-stock funds and both of its foreign-equity funds employ multiple subadvisors, which makes its equity exposure even more wide-ranging. Although exceptionally diversified portfolios can lead to middling results, this fund has earned an impressive long-term record because of the quality of its underlying offerings.

Meanwhile, this fund's aggregate international-equity weighting is slated to increase to 19.5% from 13%, which will boost its overall diversification and its already-considerable appeal as an all-in-one vehicle. Furthermore, Wellington Management and Delaware Investments have taken over the two thirds of  Vanguard U.S. Growth (VWUSX) that AllianceBernstein used to run. (William Blair will continue to run the other third, but James Golan and Tracy McCormick, who have been with the firm since the early 2000s, will take over that portion from John Jostrand at the end of 2010.) U.S. Growth has been the weakest member of this fund's underlying offerings, and the new subadvisors should help it improve. This fund has seen approximately $130 million in outflows over the past year, but it still has $13.2 billion in assets, and its composition and management changes should bolster its appeal to one-stop shoppers.

Conclusion
The pattern of cash flows for the allocation lineup at Vanguard over the past year replicates that of the domestic-hybrid universe overall, with most conservative-allocation funds enjoying inflows and the majority of moderate- and aggressive-allocation offerings suffering outflows. But the rest of the picture isn't mixed. The changes at some of the firm's hybrid funds are positive developments, and its overall allocation lineup remains quite strong. And investors who want a stock-bond package will continue to find excellent options across the risk/reward spectrum at Vanguard.  

That said, interested investors should note that Vanguard's conservative-, moderate-, and aggressive-allocation funds do not get tamer automatically over time. Of course, Vanguard's target-dates offerings do get more reserved as time passes, and they are among the best such offerings around, so they are terrific one-stop solutions for investors seeking to keep their retirement-savings plans simple.