The broad U.S. stock market finished flat over the six months ended April 30, 2016, but its path over the period was quite bumpy. After a difficult start, stocks rebounded as the economy showed some improvement, oil prices increased, and the Federal Reserve indicated it would pare back its original plan for short-term interest rate hikes in 2016.
In the most recent Vanguard fund reports, the two advisors that manage the Windsor Fund offered insights into their investment process and the financial markets. The fund focuses on so-called value stocks, which tend to sell at relatively low prices in relation to their earnings or book value.
In their letter to shareholders, portfolio managers from Wellington Management Company LLP and Pzena Investment Management, LLC, discussed how the economy could affect their respective portions of the fund’s holdings.
“Looking ahead, we believe near-term recession risks have diminished, which provides a better backdrop for many of our cyclical holdings,” wrote Wellington’s James N. Mordy. “We remain relatively bullish on the energy sector after producers’ dramatic cutbacks in drilling. However, global nominal growth remains disappointingly slow despite aggressive monetary stimulus. Many longer-term worries are still unresolved, and with little margin for error, the economy remains vulnerable to any unforeseen shocks. It’s difficult to have high conviction in longer-term macroeconomic forecasts.
“We think our best investments will be in companies with good management teams that can drive value through internal improvements. We expect markets to stay volatile and will endeavor to use swings in investor sentiment to identify new longer-term value opportunities for shareholders.”
Richard Pzena, John P. Goetz, and Benjamin S. Silver of Pzena described how the market turmoil in the period’s first half created investment opportunities. They also discussed the sectors of the market that make the most sense for their value-oriented style.
“In the past, valuation spreads have often been a strong predictor of favorable value investing environments,” the trio wrote. “Spreads have consistently widened since 2011 and approached attractive levels in mid-February. We made some adjustments to our energy and financial holdings to take advantage of the opportunity. Together with mature technology investments, these are now our largest exposures. We have less exposure to sectors deemed ‘safe,’ such as health care, consumer staples, utilities, and telecommunications.”
While the Windsor Fund invests in value stocks, Vanguard Mid-Cap Growth Fund is devoted to the opposite end of the investing-style spectrum: growth stocks, which are typically pricier than their value counterparts. These higher valuations reflect the perceived greater earnings potential of the underlying companies.
Opportunities for growth
The fund’s two advisors—Chartwell Investment Partners, LLC, and William Blair Investment Management, LLC—separately strive and strategize to achieve the goal of long-term growth with methods that are similar in some ways and different in others.
Although the fund has beaten its benchmark by more than 2 percentage points since its December 31, 1997, inception, the six-month reporting period ended April 30, 2016, wasn’t as productive. The fund returned –5.45%, trailing its benchmark, the Russell Midcap Growth Index, by nearly 4 percentage points.* Over the half year, value stocks outpaced growth, and mid-capitalization stocks led large-caps and small-caps.
“More than ever, stock selection seems central to investment performance,” wrote John A. Heffern, Chartwell’s portfolio manager. “Accordingly, we are navigating these uncertain times with a portfolio focused on mid-capitalization companies demonstrating above-average growth potential supported by good products and expanding markets. This approach leads to portfolio decisions that steadfastly reflect our bias toward quality, leadership, defensible margins, and a pattern of successful execution around growth-oriented business models.”
Robert C. Lanphier and David Ricci, William Blair’s portfolio managers, explained how an investment climate that favors high-dividend-yielding stocks doesn’t always benefit a fund that’s primarily oriented toward growth.
“From a style perspective, our bias toward companies with less-volatile fundamentals helped—but it was counterbalanced by our bias toward companies with higher growth,” Messrs. Lanphier and Ricci wrote. “The latter bias resulted in lower-dividend-yield exposure, and investors strongly favored high-dividend-yielding stocks in the first six weeks of 2016. Our portfolio tends to significantly underweight such companies, preferring sustainable growth companies that have significant reinvestment opportunities to enable superior, durable long-term growth.”
Vanguard is widely identified with indexing investing as our founder, John C. Bogle, launched the first index mutual fund for individual investors in 1976. But we’re also fully committed to active management, and our lineup of active funds includes Vanguard Wellington™ Fund, which dates back to 1929.
Index and active in sync
In his closing remarks in letters to shareholders, Vanguard Chairman and CEO Bill McNabb clarified how our index and active approaches are compatible.
“To us, it’s not index versus active. In fact, depending on your goals, it could well be index and active,” Mr. McNabb wrote. “Our index and active funds share important traits. Both are low cost, and as their assets grow, we can take advantage of the economies of scale by further reducing fund expense ratios. That allows you to keep more of your fund’s returns.
“And low costs aren’t the whole story. Talent and experience are vital regardless of a fund’s management style. . . . There’s no guarantee that active management will lead to market-beating results, but the combination of talent and low costs can give investors a better chance of success.”
Other recently published reports:
Vanguard Explorer™ Fund
Vanguard International Explorer Fund
Vanguard International Value Fund
Vanguard Municipal Bond Funds
Vanguard Selected Value Fund
Vanguard Windsor II Fund
*Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index. Benchmark comparative indexes represent unmanaged or average returns on various financial assets, which can be compared with funds’ total returns for the purpose of measuring relative performance. Visit vanguard.com for updated Vanguard fund performance.
All investing is subject to risk, including the possible loss of the money you invest.
Prices of mid- and small-cap stocks often fluctuate more than those of large-company stocks.