They don’t come any bigger than Vanguard mutual funds. With $1.3 trillion in assets and more than 100 mutual funds, Vanguard offers a lot of top 401k fund options to investors looking for a one-stop shop. Its rock-bottom expenses make it the low-cost fund family — and lower expenses boost returns for your 401k.
But Vanguard is best known for its index funds — the indexing revolution was actually pioneered by the Valley Forge, Pa.- based fund giant. Vanguard has index funds for almost everything, whether as open-ended mutual funds or exchange-traded funds. You can index the S&P 500 Stock Index, the Russell 2000 Index of smaller companies, growth stocks, value stocks, small cap growth and value stocks or the whole universe of U.S. and international stocks.
Our screen for Vanguard’s best funds turned up six — two actively managed mutual funds and four index funds. We screened for diversified U.S. equity funds still open to new investors, under the same management team for at least three years and ranked four or five stars (out of five) by independent fund analysis firm Morningstar Inc. Then we identified those funds that had outperformed the 8.5% return of the S&P 500 over the year ended August 20.
We will focus on the two active funds and just two of the index funds because they are somewhat unique. We assume investors looking for the best funds want to outperform benchmarks rather than mimic them. Index funds are easy enough to choose — Vanguard is certainly the best place to find open-ended index mutual funds — the only question is the relative weight to give each one. Top actively managed funds are harder to find.
One of the index funds that merits discussion is the Vanguard Dividend Appreciation Index because it is a rare stock index fund that gets five stars from Morningstar and represents a segment of the market many investors are gravitating to now — solid, dividend paying companies for uncertain times. The second is the Vanguard LifeStrategy Growth Fund, which divides its assets mostly among other Vanguard index funds, providing a simple asset allocation solution for growth oriented investors.
The other index funds that passed the screen were the Vanguard Small Cap Growth Index Fund, designed to match the MSCIUS Small Cap Growth Index, and the Vanguard Growth Index Fund, modeled after the MSCIUS Prime Market Growth Index of large growth stocks.
All of the four funds below follow a buy-and-hold approach with annual portfolio turnover of 30% or lower.
#1 – Vanguard Dividend Appreciation Index Fund (VDAIX)
Manager: Ryan E. Ludt (since 2006)
Total assets: $4.0 billion
Expenses: 0.35%
Minimum initial investment: $3,000
Yes, Vanguard truly does have an index fund for everything. But only one equity index fund gets five stars from Morningstar. Vanguard Dividend Appreciation Index Fund (VDAIX) tracks the performance of Mergent Inc.’s Dividend Achievers Select Index of companies that have increased their dividends over time. The ability to increase dividends over time can be seen as a key indicator of a company’s financial health.
The Dividend Appreciation Index Fund yields 1.9%, slightly less than the S&P 500, so it shouldn’t be confused with an income fund. (Vanguard also has the High Dividend Yield Index Fund, a four-star fund yielding 2.7% that just barely missed our criteria because it has slightly lagged the S&P 500 over the past year.)
Dividend Appreciation has returned +9.5% over the past year and also has outperformed the S&P 500 year to date (-0.6% versus -2.6% as of Monday) and over three years (-3.9% annually versus -7.4%) with less volatility. It has beaten its Morningstar Large Blend category year to date and over the past one- and three-year periods. The fund lacks a five-year track record. But the fund lost just -26.6% in the 2008 bear market versus -37.0% for the S&P 500.
The Dividend Appreciation Fund is concentrated, with about 40% of net assets in the top 10 holdings.
The top five holdings as of June 30 were a who’s who of stability: PepsiCo Inc. (NYSE: PEP), Procter & Gamble Co. (NYSE: PG), McDonald’s Corp. (NYSE: MCD), International Business Machines Corp. (NYSE: IBM) and Johnson & Johnson (NYSE: JNJ).
#2 – Vanguard Dividend Growth Fund (VDIGX)
Manager: Donald J. Kilbride (since 2006)
Total assets: $3.5 billion
Expenses: 0.38%
Minimum initial investment: $3,000
Speaking of dividends, here’s an actively managed Vanguard offering that also focuses on dividend growth and also rates five stars: the Vanguard Dividend Growth Fund (VDIGX). It has outperformed the Dividend Appreciation Index Fund over the past three years and also has a strong 10 year track record (though manager Donald Kilbride has only been on the job for four years). The fund yields 2.2%.
The Dividend Growth Fund has returned 9.6% over the past year and also has outperformed the S&P 500 year to date (-2.4% versus -2.6%) and over the past three years (-2.9% annually versus -7.4%) and five years (3.0% annually versus -0.5%). It has done so with considerably less volatility. The fund has handily outperformed its Morningstar Large Blend category year to date and over the past one-, three- and five-year periods. Dividend Growth is the third best fund in the category over five years and the fifth best over three years. The fund lost just -25.6% in the 2008 bear market versus -37.0% for the S&P 500.
Its top holdings as of June 30 were Automatic Data Processing (NASDAQ: ADP), Johnson & Johnson (NYSE: JNJ), International Business Machines Corp. (NYSE: IBM), United Parcel Service (NYSE: UPS), and Cardinal Health Inc. (NYSE: CAH).
#3 – Vanguard Selected Value Fund (VASVX)
Managers: James Barrow (since 1999), Mark Giambrone (2002), Richard Lawrence Greenberg (2005), Donald Gene Smith (2005)
Total assets: $3.4 billion
Expenses: 0.47%
Minimum initial investment: $25,000
We highlighted the Vanguard Selected Value Fund (VASVX) earlier this month and with good reason. The fund outperformed the S&P 500 in both the 2008 bear market (-35.5% versus -37.0%) and the 2009 rebound (36.3% versus 26.5%).
Selected Value has bested the S&P 500 year to date and over the past one-, three- and five-year periods. But most impressive is its 10-year average annual return of 8.5% versus -0.8% for the S&P 500. The fund also has outperformed its Morningstar Mid-Cap Value category in all those time periods.
The fund is team-managed by two separate outside advisors, with about three quarters of the portfolio managed by Barrow, Hanley, Mewhinney & Strauss LLC and a quarter by Donald Smith & Co. Lead manager James Barrow also is the longtime manager of Vanguard’s giant Windsor II Fund. The advisors look for companies with below-average valuations based on measures such as earnings and book value.
Selected Value’s top holdings as of June 30 included Pinnacle West Capital (NYSE: PNW), Yamana Gold (NYSE: AUY), Goodrich Corp. (NYSE: GR) and Capital One Financial Corp. (NYSE: COF).
#4 – Vanguard LifeStrategy Growth Fund (VASGX)
Manager: Various
Total assets: $7.0 billion
Expenses: 0.23%
Minimum initial investment: $3,000
The Vanguard LifeStrategy Growth Fund (VASGX) mixes together some index funds and an asset allocation fund to provide a mix of bonds and U.S. and international stocks. Since it’s a fund of funds, no one fund manager is listed at the helm. The fund’s board of trustees manages the asset allocation, with a target of 80% stocks and 20% bonds. About 25% of the fund is invested in the Vanguard Asset Allocation Fund managed by Mellon Capital Management. Though that fund only rates two stars, the overall LifeStrategy Growth Fund merits four stars. About 50% of the fund is invested in the Vanguard Total Stock Market Index, giving investors exposure to mid caps and small caps as well. About 15% of the fund is invested in the Vanguard Total International Stock Index Fund while 10% is invested in the Vanguard Total Bond Market II Index Fund.
As of June 30, about 79% of the fund was in stocks, 14% in bonds and 7% in cash. It’s a good one-decision fund for investors who seek primarily growth but also want built-in exposure to bonds to dampen the volatility of an all-stock portfolio. Vanguard also offers a suite of other LifeStrategy funds for investors with different risk tolerances: LifeStrategy Conservative Growth, LifeStrategy Moderate Growth and LifeStrategy Income. The latter is a four star fund not included in our list because it is an income fund; the other two rate three stars.
LifeStrategy Growth Fund’s diversification has worked well for investors over time, as it is supposed to. The fund has outperformed the S&P 500 and its Morningstar Large Blend category year to date and over the past one-, three-, five and 10-year periods. Over 10 years the fund has returned an annualized 1.63% compared with -0.8% for the S&P 500. Over 15 years, LifeStrategy Growth Fund has only matched the S&P 500’s 6.4% average annual gain, but with less volatility. The fund has outperformed its Morningstar peer group in that time period.
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