What a Shuffle of Subadvisors Means for This Vanguard Fund

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A large asset-allocation team, solid underlying managers, and low fees solidify T. Rowe Price Retirement Balanced's Morningstar Analyst Rating of Silver.

This fund served as the landing point in the firm's Retirement target-date series from 2002 until 2004, when the glide path stopped derisking at 40% in equities 10 years past retirement. In 2004, the firm revisited the glide path and decided to continue trimming equities until 30 years past retirement; at that point, the stock weighting levels off at 20%. As a result, this fund was eventually decoupled from the series.

Vanguard Windsor II's recent revamp leaves the fund with four subadvisors who have enough strengths to upgrade the Admiral shares' Morningstar Analyst Rating to Bronze; the higher-priced Investor shares stay Neutral, though.

On Dec. 16, 2019, Vanguard dismissed subadvisors Barrow, Hanley and the firm's in-house Quantitative Equity Group, and added Aristotle Capital alongside Lazard, Hotchkis & Wiley, and Sanders Capital. These changes came roughly 18 months after Lazard's Andrew Lacey replaced Christopher Blake as lead manager on its portfolio sleeve. Although Lacey has been a named manager on Lazard U.S. Equity Focus LZUSX for 15 years, the strategy he is using here doesn't have a public record and has become less value-oriented.

That tweak to Lazard's strategy and Aristotle's addition could augur the fund's move toward the large-blend portion of the Morningstar Style Box. Aristotle's other portfolios also tend to shade toward blend, whereas Barrow, Hanley, which had run more money here than any other subadvisor, is a traditional value manager. If Lazard and Aristotle remain true to form, most of the fund's assets will be in core-oriented approaches. As of late 2019, Lazard's sleeve had 37% of assets, with another 21% going to Aristotle, whose strategy clone Harbor Large Cap Value HAVLX has long been in the large-blend Morningstar Category. Sanders (21%) is contrarian, but only Hotchkis (21%) has an appetite for deep-value stocks.

Each subadvisor has talented investors. Howard Gleicher of Aristotle, for example, has built a competitive record versus the S&P 500 running Harbor Large Cap Value since mid-2012, and here he has a lower fee hurdle.

Still, the fund's subadvisor combination is new and the overlap in their investment styles could amplify risks. Prior to the revamp, the fund's September 2019 portfolio had a hefty weighting in software stocks like Microsoft MSFT versus the Russell 1000 Value Index, as did Aristotle's strategy.

The fund's prospects are improved, but its character has been altered, too. Its days of overweighting hard-to-love stocks are likely in the past.

Process | Average The fund's four-subadvisor lineup, in place only since late 2019, has greater potential for investment style overlap and could amplify portfolio risk, if not shift the fund's style box from large-value to large blend, so it merits an Average Process rating.

Lazard's 37% slice now has the biggest impact, and it's even less value-oriented than it was a few years ago. It still focuses on stocks that seem cheap relative to their companies' margins and returns on invested capital, but in July 2018, it ceased investing in significantly mispriced stocks.

The remaining three subadvisors run about 21% of assets each and span the style spectrum from blend to deep value. Aristotle Capital's value-leaning, core strategy looks for firms with sustainable competitive advantages that are trading at attractive valuations and have an identifiable catalyst. Reversion-to-the-mean manager Sanders Capital seeks to profit from short-term mispricings that are due to market overreactions. Deep-value manager Hotchkis & Wiley looks for companies whose stumbles have caused them to trade cheaply based on their normalized earnings and that have a good shot of recovering.

With more than half of the assets in the core-like approaches of Lazard and Aristotle, the fund is different from the days when traditional value manager Barrow, Hanley ran most of the money here.

Following the Dec. 16, 2019, subadvisor shakeup, the portfolio will hold fewer stocks, but it isn't likely to become much more concentrated. Under the previous lineup, about a third of the portfolio's roughly 260-290 stocks soaked up less than 1 basis point of the fund's assets individually (in contrast, the top 10 holdings each account for 2% to 4%). Many of these small positions likely emanated from now former subadvisor Vanguard Quantitative Equity Group, which ran 1% of assets in recent years and took up small positions in several hundred stocks. New subadvisor Aristotle Capital will invest its sleeve in roughly 40 stocks, about the same as former subadvisor Barrow, Hanley.

The fund's current subadvisor lineup of Lazard, Hotchkis & Wiley, Sanders Capital, and Aristotle will probably hasten the portfolio's shift away from hard-to-love stocks, such as tobacco companies, to value opportunities in higher-growth areas like technology. The fund's tech overweight versus the Russell 1000 Value Index had been in the high single digits for years but peaked at 10 percentage points in September 2019. It included top-holding Microsoft, which first entered the portfolio in late 2004, not too long after initiating a dividend, and a top-10 position in Oracle ORCL.

The portfolio's mega-cap tilt should lessen, too, as Aristotle's sleeve includes some mid-cap companies while Barrow, Hanley stuck to large-cap stocks.

People | Average The fund receives an Average People rating because of uncertainty following the fund's recent subadvisor shakeups and asset reallocations.

On Dec. 16, 2019, Vanguard dismissed subadvisors Barrow, Hanley and Vanguard's in-house Quantitative Equity Group and added Aristotle Capital alongside Lazard, Hotchkis & Wiley, and Sanders Capital. These changes came roughly 18 months after Lazard's Andrew Lacey replaced Christopher Blake as lead manager on its portfolio sleeve. Although Lacey is experienced, the strategy he is using here doesn't have a public record and it no longer invests in significantly mispriced stocks, as Blake's did.

That tweak to Lazard's strategy and Aristotle's addition, could augur the fund's move toward the large-blend portion of the style box. Aristotle's other portfolios also tend to shade toward blend, whereas Barrow, Hanley, which had run more money here than any other subadvisor, is traditional value manager. If Lazard and Aristotle remain true to form, most of the fund's assets will be in core-oriented approaches. As of late 2019, Lazard's sleeve had 37% of assets, with another 21% going to Aristotle, whose strategy clone Harbor Large Cap Value has long been in the large-blend category. Sanders (21%) is contrarian, but only Hotchkis (21%) has an appetite for deep-value stocks. Each subadvisor has considerable investment talent but their combination here is new.

Parent | High The Vanguard Group entered a new era in early 2019 with the passing of its founder and conscience, John C. Bogle. Unlike its mid-1970s origins, when outflows were the norm and its survival was in question, Vanguard now wears the crown as the world's biggest retail asset manager. More than 90% of its USD 5.6 trillion in global assets under management, as of June 2019, are in the United States; but the firm has designs to grow its non-U.S. business, especially in the United Kingdom, Australia, Canada, Japan, China, and Mexico.

Vanguard gained its stature by following Bogle's playbook: pairing relatively predictable strategies, both passive and active, with minimal costs. That's enriched Vanguard's investors, and those outside its flock who have benefited from industrywide fee compression. While Vanguard's passive business now faces stiff price competition from its biggest rivals, inflows into its U.S. strategies still dominate.

Not content, Vanguard aims to transform investment advice, too. In May 2015, it launched Personal Advisor Services, a burgeoning discretionary asset-management business that pairs automation and human advice; and in September 2019 it disclosed plans to launch a digital-only counterpart. Vanguard's industry leadership readily merits a High Parent rating, but the firm must stay on its guard to prioritize investor interests over merely expanding its kingdom.

Performance Prior to its recent subadvisor shakeup and asset reallocation, the fund had a competitive record against most large-value category peers, but it hadn't beaten its benchmark. Between the March 2014 firing of subadvisor Armstrong Shaw and the late 2019 dismissal of Barrow, Hanley, the fund's 9.2% annualized return through Dec. 16, 2019, lagged the Russell 1000 Value Index by 7 basis points.

Although the fund's results haven't strayed too far from those of the benchmark, they look worse when adjusted for risk. The fund lost more than Russell 1000 Value in the 2015-16 correction and in late 2018's near bear market, for example.

Hotchkis & Wiley's deep-value portion of the portfolio seems to have contributed to underperformance during the 2015-16 correction. Deep-value stocks got hit hard during that correction, and Hotchkis & Wiley's allocation within the portfolio increased to 12% by 2015 from 7% in 2013. Meanwhile, Hotchkis & Wiley Diversified Value HWCAX, a clone of the strategy the firm runs here, lagged badly in the correction.

Still, the fund's biggest challenge since 2016 has been the performance of Barrow, Hanley's sleeve under the successors to longtime manager James Barrow. Through November 2019, Vanguard VIF Diversified Value, a clone of that strategy, had an annualized gross return of 9.8%, versus 11.6% for Vanguard Windsor II, overall, and 11% for the index.

Price It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar Category's cheapest quintile. Even so, based on our assessment of the fund's People, Process, and Parent Pillars in the context of these fees, we don't think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Neutral.