How to Use Vanguard's Bookend Funds

A little over a year ago, Vanguard launched a pair of new funds: Vanguard U.S. Value  and Vanguard Growth Equity . While a year is too short a time period to determine the skill of the funds’ managers, it does tell a story about what to expect and how to use these funds.

The two funds are run by institutional money managers and it shows. Both stick to very strict investment disciplines that keep them tightly in line with their respective benchmarks. What that means is that these funds have more-narrow investment universes than most large-cap funds and they won’t bail out of a sector just because they think another offers more attractive investments. That discipline is a valuable risk control of a sort, but only if you use the funds the right way.

Institutional investors such as a pension funds like that tight discipline because it enables them to maintain precisely the level of diversification they want. If the managers had more freedom, the pension fund might find that too much of its money was in one sector at the same time and it’d be too exposed to that sector. In order for those risk controls to work for you, the individual investor, you need to balance the extreme growth fund with the extreme value fund. Otherwise, the discipline might not help.

These two funds have put up starkly contrasting 12-month returns (for the period ended October 24). U.S. Value has lost just 0.04% and that’s 21.35% less than the S&P 500 has lost. Unlike some value managers, Chris Darnell and Robert Soucy didn’t chase growth stocks in order to keep up with the S&P 500. Their discipline bars them from it.

Meanwhile, Robert Turner was keeping Vanguard Growth Equity’s sector weights right in line with the Russell 1000 Growth index’s. He looks for fast-growing stocks but pegs sector weightings to the index’s whether he likes those sectors or not. Translation: The fund was loaded up on tech. Admittedly, other growth managers had even bigger bets, but this one still had a lot. Growth Equity has lost 48.07% over the past 12 months and that’s 26.68% worse than the S&P 500.

Growth Equity got whupped even when compared with other large-growth funds, while U.S. Value’s value discipline had it well ahead of other large-value funds. Put them together and what do you get? Well, about five percentage points less than if you’d simply owned Vanguard 500 Index (VFINX). (Bogleheads are now invited to say "Told you so!")

These funds might do better in tandem in the end. My point here is that disciplined funds like these work best in disciplined portfolios because they’re sure to have their ups and downs.

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