4 Funds to Buy for Portfolio Security in 2014
Avoid chasing overvalued stocks in 2014
In a market that, on average, is most overvalued in the small-cap and mid-cap space, the most compelling valuations remain in large-cap funds that aren’t chasing overvalued stocks.
Large companies with battleship balance sheets offer not only the most compelling value, but also yield. And with the right manager at the helm, they offer the best chance of outperforming a down market.
The Vanguard Dividend Growth Fund (VDIGX), Primecap Odyssey Aggressive Growth (POAGX), Primecap Odyssey Growth Fund (POGRX) and Vanguard International Growth Fund (VWIGX) all fit the bill as funds that are buying value, rather than paying up for growth.
Classic growth-and-income value manager Donald Kilbride says his goal for Vanguard Dividend Growth Fund (VDIGX) is to create a portfolio that will produce a steady and growing stream of dividends. He looks for companies that have both the ability and the willingness to pay dividends and increase them over time. Unlike his predecessor and some competitors, Kilbride does not believe in buying non-dividend-paying companies that may begin to offer a payout — he wants a current yield, now.
The fund is concentrated, with about 50 holdings, and between 25% and 30% of assets are in his 10 favorites, with United Parcel Service (UPS), McDonald’s (MCD) and Microsoft (MSFT) currently in the top three holdings. And the expense ratio is a low 0.29% — or $29 per $10,000 invested.
Kilbride isn’t concerned with having the highest current yield in the fund arena — he believes that a growing yield will be accompanied by growing capital values, and this will provide a good total return to shareholders. What he seeks is to build a portfolio that grows its dividend, putting more cash into shareholders’ pockets every six months (the fund pays semiannually, not quarterly).
This is a great fund that could easily serve as your core stock holding. During the 2007 to 2009 credit crisis, the fund’s maximum cumulative loss was a relatively shallow -38.0%, one of the smallest among all of Vanguard’s equity funds.
Vanguard has set up a horse race with Vanguard Dividend Appreciation ETF (VIG), as both funds now share the same bogey for performance measurement. I’m partial to the active fund, as Kilbride has proven his worth over time, but this is the closest ETF substitute.
Primecap Odyssey Aggressive Growth
I can’t say enough good things about the team at Primecap Management, I do believe their Vanguard Capital Opportunity Fund (VHCOX) is too big for its britches. Instead of being the small-cap/mid-cap fund that it was in its early years, has shifted its focus to larger-cap stocks. That’s not bad, but it’s an evolutionary change that you should be aware of.
The strategy here is something called growth-at-a-reasonable-price, or GARP investing. The managers are most interested in companies that can grow earnings at a better-than-market rate, but unlike most growth managers, they refuse to pay high prices for the companies’ stocks. So they wait.
Primecap’s team is fairly unique. Each manager takes a slice of the portfolio and invests as he sees fit. Though there is no collaboration on holdings, per se, several managers may find value in the same stocks. The research team also gets a small piece of the pie to share their best ideas.
This makes the fund resilient to manager changes. Primecap has seen some manager changes the past years as it enters into its fourth decade. In 2010 David Van Slooten (who left the firm), was replaced by research chief M. Mohsin Ansari, who has had a role on the fund for about a decade. In 2012, Primecap co-founder Howard Schow passed away. And at the end of 2013 co-founder Mitch Milias (not a named manager here, but with responsibilities on Primecap and Primecap Core) announced he was stepping away from portfolio management.
I think the Primecap team is a cut above, and has handled these changes in stride. The best way to access them is through the Primecap Odyssey funds. Despite higher expenses (0.67%, which is still well below the industry average) Primecap Odyssey Aggressive Growth (POAGX) — the fund that most resembles what Capital Opportunity looked like with fewer assets — has run circles around its big brother.
Note that while the capital opportunity fund is officially closed, Vanguard’s Flagship clients can open new accounts here. But why bother? Buy the Odyssey option instead.
Primecap Odyssey Growth Fund
Vanguard Primecap Fund (VPMCX), like siblings Capital Opportunity and Vanguard Primecap Core Fund (VPCCX), is run in much the same way — with each member of the Primecap team running his portion independently for growth at a reasonable price. The managers like to buy a stock when its price is falling and then sell it when the price is rising. In other words, they don’t trade with the crowd; they buy future-earnings-growth at much lower multiples than investors who chase the hot performers.
This fund does lots of things right. It’s concentrated with about 40% in the managers’ 10 favorite stocks. Technology and healthcare stocks each soak up over 30% of assets. And turnover is low, in the teens and single digits.
There’s no question that Primecap can be volatile. But returns have been worth the risk. Compared to Capital Opportunity, it’s more conservative with more large stocks in the mix, though their portfolios can share many holdings and are looking increasingly similar. You can do better, though, by buying the Primecap Odyssey Growth Fund (POGRX), which has handily outperformed due in part to its smaller asset base.
While some of Vanguard’s wealthiest investors can still invest in this closed fund, I’d recommend using the Odyssey option instead, particularly now that you can do so through Vanguard Brokerage.
If you’d like to add additional diversification, going international is another option. Again, active management is outpacing the indices here. Compared to Vanguard Total International Stock Index Fund (VGTSX) or Vanguard Developed Markets Index Fund (VDMIX), the actively-managed Vanguard International Growth Fund (VWIGX) has pulled ahead.
Remember that even relatively small advantages, like 1% to 2% a year can really add up when compounded over time.
Performance Since Oct. 2005
|Fund||Avg. 3-Year Rolling Returns||Avg. 5-Year Rolling Returns|
|International Growth Fund||8.5%||7.1%|
|Total International Index||7.8%||7.0%|
|Developed Markets Index||6.8%||5.8%|
One of the fund’s three managers, Virginie Maisonneuve of Schroder, has left to become the Global Head of Equities Portfolio Management at Pimco, but I retain a “Buy” rating on International Growth. The expense ratio is a moderate 0.49%, slightly better than average for international growth funds. This remains a solid choice for investors looking for one-stop shopping for foreign stock exposure.
Dan Wiener may hold some of the aforementioned securities in his Independent Adviser for Vanguard Investors portfolio.