by Dan Wiener | September 10, 2013 8:43 am
Opportunity remains, but check your expectations at the door. That was my message on aggressive growth funds last month, and — spoiler alert — it applies to large growth funds as well.
Let’s start at the beginning: What do I mean by growth?
I consider a growth stock one where a company is growing earnings faster than the overall market, and is generating little or no yield. Over the past several years, some growth companies have built up huge cash hoards, and a few, like Apple (AAPL), have recently given in to the pressure and started to return some of that money to shareholders in the form of dividends and hefty stock buybacks.
While profit growth defines growth stocks, it’s a different story for growth funds. In my book, a growth fund is one where the emphasis is on capital appreciation, not generating income. Some fund managers aim to accomplish this by searching for companies where profits are growing rapidly. Other managers look for companies whose assets are so undervalued that market recognition of that value will generate great price appreciation. Some commentators split this between growth and value investing, but to my way of thinking they are two sides of the same coin.
What I’m looking for in a growth fund is the ability to power a portfolio by producing long-term gains that can be banked five, 10, 20 or even 40 years into the future.
Read on to learn about three of Vanguard’s large growth fund offerings.
Buy. The Primecap Management team has delivered market-beating returns in the Vanguard Primecap Fund (VPMCX) over a very long stretch of time. How do they do it?
As with all of Primecap Management’s funds, this one is a growth-at-a-reasonable-price, or GARP, fund. The managers look for companies with the potential for strong earnings growth, but which are currently selling for less than comparable growth companies — most likely because there’s some negative factor influencing most investors’ perception of the company’s value. Each of the five managers is responsible for managing a sleeve of the fund. The end result of this approach is a high-conviction portfolio with 131 stocks and over one-third of the assets in the 10 largest holdings. The fund does hold some mid-caps, though by dint of its size, large-caps play a predominant role in the portfolio.
While the long-term track record is impressive, keep in mind that Primecap does not beat the market month in and month out. In fact, since the fund’s inception, it has only outperformed Vanguard 500 Index Fund (VFINX), 56% of the time on a monthly basis. But when Primecap outperforms, it more than makes up for the times it lags by a large margin.
While this fund is closed to new investors, its near-clone, Primecap Odyssey Growth (POGRX), is wide open and, because of its smaller size, is nimbler and has substantially outperformed this granddaddy since its introduction in November 2004. Through August 2013, the new fund is up 126.7% versus 104.6% for gramps.
Vanguard offers the Odyssey funds through its brokerage service, and as I have long recommended, unless taxes you’ll pay selling your Vanguard holdings are a concern, you have no excuse for sticking with the original, which is still great, but not as great. At a minimum, I’d take any distributions Primecap makes and invest them in the Odyssey fund.
Hold. At what point does an active fund become an index fund?
Vanguard has managed to keep from hiring or firing anyone at Vanguard Morgan Growth Fund (VMRGX) for nearly five years, but with five different firms sub-advising Morgan Growth, what you get is a middle-of-the-road, no-conviction mid- to large-cap growth stock amalgam. With five firms stirring the pot, no one can do too much damage on their own — but they can’t really drive performance higher, either.
Though its low expenses make it an able competitor in the broad mutual fund universe, the fund has continued to lag its Russell 3000 Growth Index benchmark since the three newest managers were hired — Jennison Associates in January 2007, and Kalmar and Frontier Capital in November 2008.
The fund is neither low-risk nor high-return. During the 2007 to 2009 market tumble, it hit a new MCL of -50.3%, compared to -52.8% for Growth Index. However, during the same period Primecap’s worst drawdown was -44.3%.
Even former Vanguard chairman Jack Bogle, years ago, said that Morgan Growth is “an average fund. It’s not a star.” If I’m not buying a star, why not just buy the index, keep costs low and accept that I’ll get average performance?
Sell. Over the long haul, Vanguard Growth Equity’s (VGEQX) performance suffers mightily from the missteps of its original manager. Turner Investments, a firm whose principals never saw a growth stock they didn’t like, has been gone for nearly five years now. Unfortunately, the two replacement sub-advisers can’t seem to beat or even match their benchmark, the Russell 1000 Growth Index, though they’ve come close.
Baillie Gifford took over a portion of the fund in April 2008, and when Turner was fired in January 2009, the portfolio was divided in half between Baillie Gifford and a new manager, Jennison Associates. As with all management changes, the hope was to breathe new life into this fund. From the end of January 2009 through August 2013, the fund has gained 121.7%, or 19.0% a year, which, on its face, isn’t shabby. But the bogey has gained 130.3%, or 20.0% a year. Growth Index has compounded at 19.6% per year over the period. I will give the managers credit for keeping pace with their Vanguard growth fund peers over that period. So there has been some improvement under the new sub-advisers, but the case still is not convincing. (And, by the way, the Vanguard Board seems to agree with me—not one director owns a share here.)
Senior Editor Dan Wiener and Editor/Research Director Jeffrey DeMaso publish The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of recent developments at Vanguard, and the annual FFSA Independent Guide to the Vanguard Funds.
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