3 Facts About the Best-Known S&P 500 Fund

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Vanguard S&P 500 is a compelling option for exposure to U.S. large-cap stocks. This fund gains a leg up over most of its category peers by efficiently tracking a broadly diversified and representative benchmark at a low cost. It earns a Morningstar Analyst Rating of Gold.

The fund tracks the S&P 500, a market-cap-weighted index that includes large-cap stocks representing about 80% of the U.S. stock market. A committee selects the index’s holdings, which offers more flexibility than indexes that adhere to rigid rules but also reduces transparency. But the S&P 500’s performance has

and should continue to be, highly correlated with large-cap indexes that follow mechanical rules.

Market-cap-weighting pulls the portfolio toward the largest U.S. stocks and accurately reflects the composition of the market. The fund’s average market capitalization of just under $100 billion is nearly double the market capitalization of the average fund in the category. Its top 10 holdings

about 20% of its portfolio and include household names like

Low turnover is a key advantage of the fund’s broad market-cap-weighted approach. Lower turnover equates to lower transaction costs and a smaller likelihood of taxable capital gains distributions. The fund’s average turnover over the past decade was 5% compared with an average figure of over 60% for its category peers. Tax efficiency adds to the fund’s appeal. It has not distributed any capital gains since its inception.

The durable cost advantage has translated into strong category-relative performance. During the past decade through February 2018, its Admiral share class outpaced the large-blend Morningstar Category by 1.6% annually. Its risk-adjusted returns, as measured by its Sharpe ratio, landed in the category’s top quintile over the same period. Because this index fund remains fully invested, it suffered a larger drawdown than the category average during the financial crisis. But its smaller cash drag pays off during bull markets. Its performance during the market recovery more than made up for its larger drawdown.

Process Pillar: Positive | Adam McCullough, CFA 03/09/2018 This fund uses full replication to track the S&P 500. This index effectively diversifies risk, promotes low turnover, and accurately represents its target market segment, supporting the Positive Process rating.

Unlike many other indexes, a committee selects the constituents for the S&P 500. These large-cap stocks represent about 80% of the total market capitalization of the U.S. stock market. The S&P 500 has a slight quality tilt because new constituents must be profitable before they are eligible to be added

the index. However, that screen probably won’t have a big impact on performance because most large-cap stocks meet this requirement. While qualifying stocks must pass some quantitative screens, the index committee has some discretion in its stock-selection process. This gives the S&P 500 a greater degree of flexibility than indexes that follow more-mechanical rules, though it also reduces transparency. Despite this difference, the S&P 500’s performance has

and should continue to be, highly correlated with other large-cap indexes that follow mechanical rules.

The portfolio managers use dividend reinvesting and derivatives to keep pace with the benchmark. The fund has historically used securities lending to generate additional income to offset expenses.

This is a well-diversified offering that captures nearly 80% of the investable U.S. equity market. Its top 10 holdings represent just under 20% of the portfolio and include household names such as Apple, Microsoft, Amazon.com, and

Many of the fund’s largest holdings are multinational firms, giving it substantial indirect international exposure. The portfolio managers reinvest dividends and use index futures to keep pace with the benchmark and manage redemptions. During the past decade through February 2018, the fund averaged only a 0.3% cash allocation, about a tenth of its average actively managed peers. The fund has historically used securities lending to generate additional income to offset expenses.

Performance Pillar:

Positive | Adam McCullough, CFA 03/09/2018

The fund has generated strong risk-adjusted long-term performance compared with its large-blend Morningstar Category peers. It earns a Positive Performance Pillar rating.

During the past 10 years through February 2018, the fund’s return topped the large-cap blend category average 1.6 percentage points each year. The funds’ cost advantage and efficient construction

contributed the most to its outperformance over the long-run. Because the fund generates its edge from its low cost, its advantage is consistent. Over the trailing 14 years through February 2018, the fund’s rolling three-year returns landed in the top half of the category 99% of the time. And because it was fully invested, this fund performed worse than the category average during the bear market drawdown from October 2007 to March 2009. But its subsequent recovery more than made up for the slightly larger drawdown.

The fund benefits from securities lending and the use of derivatives to efficiently track its index. It has not distributed a capital gain over the prior decade. And its annualized tax-cost ratio was 0.5% over the past 10 years, compared with the 0.9% average of all S&P 500-tracking funds. That places this offering in the top decile of S&P 500-tracking funds.

People Pillar: Positive | Adam McCullough, CFA 03/09/2018 A well-equipped group manages all of Vanguard's equity index funds. The team's extensive experience, deep bench of talent, and strong trading infrastructure underpin this fund's Positive People Pillar rating.

Donald M. Butler, CFA, principal of Vanguard Group, has been with Vanguard since 1992, has managed investment portfolios since 1997, and comanaged this fund since 2009. Butler took over as a named portfolio manager on the fund with Scott Geiger in April 2016 when Michael Buek stepped down. Buek, a veteran Vanguard manager, remains a co-head of the Equity Index Group and trading teams. Michelle Louie took over as co-portfolio manager for Geiger in November 2017. Louie has been in portfolio management since 2012 and with Vanguard since 2010. Butler and Louie also manage the Institutional version of this fund, VINIX.

According to the Statement of Additional Information, Louie has over $100,000 invested in the fund. Butler is not currently invested, but Vanguard links the managers' compensation to operating efficiency, which helps keep costs low and aligns their interests with investors’. Minimizing costs and tracking-error are their primary objectives. Vanguard has automated much of this process and provides the managers with robust tools to handle flows, corporate actions, and benchmark changes.

Parent Pillar:

Positive | 12/12/2016

Vanguard has one of the mutual fund industry’s strongest corporate cultures and earns a Positive Parent rating. Its consistent messages to investors to keep costs low, diversify, and stay the course

reflected in the firm’s own behavior. Vanguard’s U.S. fundholders own the firm through small investments by each mutual fund, mitigating potential conflicts of interest that can exist at other firms that are serving two masters. Fund performance is strong overall: Over the past three-, five-, and 10-year periods, its Morningstar Success Ratios are greater than 70%--high among large, diversified fund families.

Over the past year, the firm has collected more than USD 200 billion in net inflows, thanks in large part to investors’ interest in passive investing. The firm's indexing and ETF prowess, low costs, and success in penetrating the financial-advisor sales channel all have fueled growth. Total assets under management now exceed USD 3.3 trillion, giving Vanguard a significant more-than-20% market share across U.S. mutual funds.

Vanguard has been a global player for years but has only more recently turned its focus to

internationally. The firm is a large player in Australia, where it has the most history, but doesn't yet have the brand recognition and trust it enjoys in the United States in other parts of the world. While non-U.S. funds don't participate in the ownership of Vanguard, the firm's

culture extends globally.

Price Pillar: Positive | Adam McCullough, CFA 03/09/2018 Vanguard charges a low 0.04% fee for the Admiral share class. This is among the cheapest S&P 500-tracking funds, which supports its Positive Price Pillar rating.

The Admiral share class carries a minimum initial purchase is $10,000. The strategy’s exchange-traded fund share class, Vanguard 500 ETF VOO, also levies a fee of 0.04% per year but does not require an initial minimum purchase beyond the cost of one share. The portfolio is also available in an Investor share class VFINX at a 0.14% annual fee and requires a $3,000 initial purchase.