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All Contents © 2019The Kiplinger Washington Editors
By Nellie S. Huang, Senior Associate Editor
| November 2, 2018
Vanguard dominates the 401(k) world. More of the company’s funds are among the list of the 100 most popular funds in workplace retirement plans than any other fund firm, says consulting firm BrightScope.
This year, 19 actively managed funds make the list – 10 are “traditional” mutual funds and nine are target-date funds, which we will analyze as a set.
We will look at some of the best Vanguard funds for your 401(k) and filter out some lesser options. We rate each “buy,” “sell” or “hold.” As always, symbols, expense ratios and trailing performance data are for the investor share class. Your 401(k) plan may offer a different share class, with lower fees.
Returns and data are as of Oct. 25, 2018. Three- and five-year returns are annualized.
Expense ratio: 0.26%
One-year return: 2.4%
Three-year return: 9.6%
Five-year return: 9.3%
Value of $10,000 invested 10 years ago: $34,180
Top three stock holdings: JPMorgan Chase (JPM), Johnson & Johnson (JNJ), Verizon Communications (VZ)
Equity Income aims to deliver above-average income and a moderate amount of capital appreciation. It has succeeded on those fronts so far, and we don’t expect that to change.
The fund, which is a member of the Kiplinger 25 (our favorite no-load mutual funds), yields 2.9%, which is more than the 2.0% yield of Standard & Poor’s 500-stock index. And since mid-2007, when the two subadvisers (more on them in a bit) began working together on this fund, Equity Income has returned an annualized 8.0%, compared with a 6.0% return for the S&P 500.
Michael Reckmeyer, of Wellington Management, and a team of Vanguard managers share duties at Equity Income. Reckmeyer handles about two-thirds of the fund’s assets and invests in 60 to 70 dividend-paying stocks. Vanguard’s team – which uses computer models to home in on stocks that score well on a variety of measures, including earnings growth rates and the history of dividend increases – picks another roughly 100 stocks selected from the FTSE High Dividend Yield index.
Although companies with household names pepper the fund’s top holdings, some of its best performers over the past year are lesser-known, including Dine Brands (DIN), a restaurant company behind Applebee’s and IHOP that gained nearly 81% over the past 12 months, and HollyFrontier (HFC), an oil and gas company stock that climbed 78%.
Expense ratio: 0.44%
One-year return: 11.7%
Three-year return: 13.2%
Five-year return: 8.9%
Value of $10,000 invested 10 years ago: $43,190
Top three stock holdings: ICON plc (ICLR), Insulet (PODD), Fortinet (FTNT)
Vanguard seems to like having multiple advisory firms managing a single fund. It’s one way to keep funds with bulging assets open; each firm is doled a slice of the asset pie to run separately. But the strategy has seen mixed results.
Vanguard Explorer, the sixth-largest small-company stock fund in the country with almost $17 billion in assets, is one such fund. Explorer has five subadvisers and a total of 11 managers. Each firm has a slightly different take on investing in the small-company stock space. Wellington Management is more price-conscious than the others. Stephens Investment Management targets rapidly growing firms. ClearBridge Investments looks for high-quality small and midsize firms. ArrowMark Partners focuses on small firms with competitive advantages. And finally, Vanguard’s in-house stock picking group uses computer models to find opportunities, using a mix of growth and value measures, among other things. Vanguard’s in-house team manages 20% of the fund’s assets; the other four advisers split the remaining 80%.
The resulting portfolio earns respectable returns, but it is disingenuous to talk about long-term returns. That’s because the cast of subadvisers has been monkeyed around with so many times in recent years. Four firms were dropped between 2016 and 2017, according to Morningstar. ClearBridge was added in March 2017. In the 18 months since then, the fund has bested the 6.3% cumulative return of the Russell 2000 index, which tracks small-cap stocks, with a 20.6% cumulative return.
Expense ratio: 0.45%
One-year return: -6.2%
Three-year return: 8.8%
Five-year return: 5.5%
Value of $10,000 invested 10 years ago: $29,440
Top three stock holdings: Alibaba Group Holding (BABA), Tencent Holdings (TCEHY), Amazon.com (AMZN)
Foreign stock markets have had an awful year. Over the past 12 months, the MSCI EAFE index, which tracks foreign stocks in developed markets, has lost nearly 8%. The index of developing markets, MSCI Emerging Markets, has plummeted nearly 13%. Vanguard International Growth, which invests in both developed and emerging-markets stocks, has held up better than both indexes. But it’s still negative for the year, with a 6.2% loss. That’s better than other funds in its peer group: funds that invest in growing, foreign firms, which lost 9.3%.
International Growth was helped by its stake – 11% compared with a typical 6% for its peer group – in several U.S. stocks, including Amazon.com and biotech firm Illumina (ILMN), both of which are among the fund’s top holdings.
This fund is aggressive. It invests in growth stocks, for starters. The two subadvisers that run the fund, Baillie Gifford (which manages 60% of the fund’s assets) and Schroders Investment Management, focus on fast-growing firms. Schroders, however, tilts more toward growth at a reasonable price. Baillie Gifford, on the other hand, is willing to pay up for companies with good long-term growth prospects (out to 10 years).
The result is a portfolio that looks and behaves differently than its typical peer. The fund has nearly double the exposure to emerging-markets stocks than its peers, 23% versus 13%, for example. It tends to be more volatile, too. Over the past three years, International Growth has been 23% more volatile than other funds that invest in fast-growing foreign stocks. The upside, of course, is the returns. Over the past three years, International Growth has returned an annualized 8.8%, well ahead of its peer group and the MSCI EAFE.
Expense ratio: 0.39%
One-year return: 9.6%
Three-year return: 14.4%
Five-year return: 13.9%
Value of $10,000 invested 10 years ago: $45,040
Top three stock holdings: Adobe Systems (ADBE), Biogen (BIIB), Alphabet (GOOGL)
This is the jewel in Vanguard’s crown. Vanguard Primecap is run by arguably the best stock pickers in the country. It’s closed to new investors, but no worries if the fund is available in your 401(k) plan. You can still invest in it, even if you’re new to the fund. Buy shares and hold for the long term.
Primecap managers Theo Kolokotrones, Joel Fried, Alfred Mordecai, M. Mohsin Ansari and James Marchetti each run an individual sleeve of the fund. But they’re each drawn to the same kind of opportunity: They look for stocks trading at bargain prices, and they aim to identify a catalyst – a new product or corporate restructuring – that they think will push a stock higher over the next three to five years. When they buy, they tend to hold. The fund’s 8% turnover rate implies a typical holding period of 12 years. Compare that with the average 55% turnover rate for its peer group: funds that invest in large, growing companies.
Primecap is truly a stunner on a performance basis. It held up better than the S&P 500 in 2008 – losing 32% compared with a 37% loss for the index. And it has trailed the large-company benchmark in just four of the past 10 full calendar years. On a trailing-return basis, the fund has beaten the S&P 500 over the past one, three, five, 10 and 15 years.
Expense ratio: 0.20%
One-year return: -0.9%
Three-year return: 1.1%
Five-year return: 0.7%
Value of $10,000 invested 10 years ago: $14,290
As its name implies, Vanguard Inflation-Protected Securities offers protection from inflation by investing in Treasury Inflation-Protected Securities, otherwise known as TIPS. Manager Gemma Wright-Casparius, who took over in 2011, can invest up to 20% of the fund’s assets in other pockets of the bond market if she sees a good opportunity.
But right now, Wright-Casparius is laser-focused on TIPS, where 97% of the fund’s assets sit. (The rest of the fund is invested mostly in cash, as well as in traditional Treasuries.)
TIPS are timely these days. Inflation is picking up – moderately, of course, but at a stepped-up pace from previous years. Over the past 12 months, according to the Consumer Price Index calculator, inflation has climbed 2.28%. Looking ahead, Wright-Casparius believes inflation will trend higher and even possibly “come in stronger” than the market expects. The difference, or breakeven rate, between the yield of 10-year TIPS, at 1.12%, and the 10-year Treasury bond, at 3.14%, implies that the market expects inflation of 2.02%.
That’s good news for TIPS holders: The principal value of a TIPS bond is adjusted upward when inflation rises. The TIPS coupon rate, which stays fixed, is applied to the new principal value, so the payout increases in step with inflation. In the first half of 2018, says Wright-Casparius, TIPS outpaced nominal Treasuries, and the inflation-adjusted principal of TIPS served as a cushion against rising interest rates (interest rates and bond prices move in opposite directions).
That doesn’t mean TIPS aren’t sensitive to rising rates. They are, because these bonds tend to have long maturities. Over the past 12 months, Inflation-Protected Securities has lost 1.5%. By contrast, the Bloomberg Barclays U.S. Aggregate Bond index dropped 2% and the typical inflation-protected bond slipped 1.3%.
Expense ratio: 0.22%
One-year return: 0.2%
Three-year return: 4.9%
Five-year return: 5.3%
Value of $10,000 invested 10 years ago: $23,140
Top three stock holdings: JPMorgan Chase, Johnson & Johnson, Cisco Systems (CSCO)
We are downgrading Wellesley Income to “hold” from “buy” because longtime bond picker John Keogh will retire in June 2019. Keogh has been the lead manager of the bond side of Wellesley Income – which accounts for 60% of the fund’s assets – since 2008.
In early 2017, he promoted two key analysts, Michael Stack and Loren Moran, to comanagers, presumably in preparation for his departure. That’s more than a two-year lead time, but we’ve seen this movie before: Even when a manager transition is well-planned and executed years in advance, things can happen and the fund suffers.
If you already own shares in Wellesley Income, stay with it. But new investors might want to wait until after the current comanagers settle in.
Expense ratio: 0.25%
One-year return: 2.2%
Three-year return: 7.4%
Five-year return: 7.4%
Value of $10,000 invested 10 years ago: $28,390
Top three stock holdings: Microsoft (MSFT), JPMorgan Chase, Verizon Communications
We’re less concerned about bond picker John Keogh’s June 2019 departure from Vanguard Wellington, Vanguard’s oldest mutual fund, than we are at Wellesley Income. That’s because bonds make up just 32% of assets at Wellington (compared with 60% at Wellesley Income).
That said, a manager change is always a time of uncertainty and a reason to be cautious. That’s why we rate Wellington, which also is a member of the Kiplinger 25, a “hold” this year, instead of a “buy.”
As for the fund’s spot on the Kip 25, our favorite no-load funds, we will be watching closely and will have more news in our May issue, when we do our annual overhaul of all of the Kip 25 funds. So stay tuned.
Expense ratio: 0.31%
One-year return: -2.5%
Three-year return: 7.0%
Value of $10,000 invested 10 years ago: $35,720
Top three stock holdings: Bank of America (BAC), Citigroup (C), American International Group (AIG)
Like many actively managed Vanguard funds, Vanguard Windsor has more than one subadviser. In this case, it has two: Pzena Investment Management and Wellington Management. The manager who runs the lion’s share of the fund – Wellington’s Jim Mordy, who takes charge of 69% of the fund’s assets – is retiring at the end of 2018. And that’s why we’re cool toward Windsor.
The fund is already kind of ho-hum. It is worth noting that value stocks, Windsor’s milieu, have been largely ignored in recent years, as investor attention has centered on go-go growth companies. But Windsor doesn’t compare well these days against its peers: funds that invest in large-companies trading at bargain prices. The fund’s three- and five-year annualized returns rank well-below-average for the peer group.
We’re struggling to find a reason to stick around. Wellington Management added David Palmer as a comanager in February 2018 to ready him as a replacement for Mordy. But Palmer’s other charge, Vanguard Capital Value (VCVLX), has been going through a rough patch since 2013. Capital Value’s five-year annualized return lands in the bottom 98% of its peers: funds that invest in large, bargain-priced companies.
The performance of Windsor over the past 12 months isn’t much better–it ranks among the bottom 93% of all large value funds. We think you’d be better off in an index fund that tracks a broad benchmark, such as the S&P 500, if one is available in your plan.
Expense ratio: 0.34%
One-year return: 3.8%
Three-year return: 8.4%
Five-year return: 8.1%
Value of $10,000 invested 10 years ago: $32,500
Top three stock holdings: Microsoft, Wells Fargo (WFC), Pfizer (PFE)
Things just got a tad more troubling at Vanguard Windsor II. The problem for years, as we’ve said in the past, has been too many cooks spoiling the stew. That’s still the case: The fund currently has five subadvisers. Each one has its own approach to value-stock investing, which we think results in watered-down performance. But we view a recent manager change at one of the subadvisers, coupled with a shift in investment style, as another strike against the fund.
Lazard, which runs 21% of the fund’s assets, named Andrew Lacey as new lead manager in July 2018. The firm used to focus on significantly mispriced, deep-value stocks. With Lacey’s arrival, it will now focus on stocks that seem cheap relative to their companies’ margin and returns on invested capital.
It’s hard to know how Lazard’s investment strategy shift will affect the fund’s performance. But it comes in the middle of a good stretch for VWNFX – its record so far in 2018 ranks among the top 30% of its peers: funds that invest in discount-priced large-cap stocks. Before that, the fund had been decidedly mediocre since 2012. Over the past three years – a window that covers the period the current subadviser team has been with Windsor II – the fund’s annualized returns match those of its benchmark, the Russell 1000 Value index, and rank in the 50th percentile of its peer group.
But finally, amid the uncertainty and middling performance, we’re scratching our heads about the increase in the fund’s expense ratio. It went up from 0.33% in 2016 to 0.34% last year. That’s not a lot, to be sure, and it’s still far lower than the majority of its peers. But a fund underperforms its benchmark and peers, and you increase the fee? Really?
There’s a lot to like about Vanguard’s Target Retirement target-date funds. They are low-cost–expense ratios for the funds in the series range between 0.13% and 0.15%. They follow a simple strategy – for most of the series, the portfolios are built around just four index funds: Vanguard Total Stock Index (VTSMX), Total Bond Index (VBMFX), Total International Stock Index (VGTSX) and Total International Bond Index (VTIBX). Vanguard Short-Term Inflation-Protected Securities Index Fund (VTIPX) is introduced in the series when there is a little less than five years to go before retirement.
And Target Retirement funds get good results: Almost all the target-date funds in the series have 10-year records that rank among the top 25% of their peer group.
Investors who don’t want to fuss over how to invest their 401(k) savings should feel confident handing over the controls to Vanguard’s Target Retirement series. Simply pick the fund with the year closest to the time you expect (or want) to retire and channel your savings into it. A pro will decide how much of your money should be invested in foreign stocks or foreign bonds versus U.S. stocks and bonds. And over time, he or she will adjust the mix of stocks and bonds to a more conservative blend as you get closer to your retirement year.
It’s a simple, one-stop investment solution.