MUTUAL FUND Investor Guide THE Investor Guide TO VANGUARD ...

[Pages:4]MUTUAL FUND Investor Guide

THE Investor Guide TO VANGUARD FUNDS



Matthew D. Sauer Founder & Chief Investment Officer

Matthew Sauer is the Founder and Chief Investment Officer of the Mutual Fund Investor Guide family of newsletters. Each month he analyzes and provides buy, sell and hold recommendations for hundreds of mutual funds and ETFs in the Investor Guide to Fidelity Funds, Investor Guide to Vanguard Funds, as well as the ETF Investor Guide.

Prior to founding the Mutual Fund Investor Guide, Matt was the President and Chief Investment Officer of the Fidelity Independent Adviser, ETF Report, and Sector Momentum Tracker.

Matt Sauer earned his Juris Doctor from Albany Law School of Union University in Albany, NY. Mr. Sauer is a licensed attorney in the State of New York. He received his Master of Business Administration, from the State University of New York at Albany and his Bachelor of Arts in Political Science and Economics from Bucknell University.

SPECIAL REPORT:

The Best Vanguard Fund for 2017: Vanguard U.S. Value Fund (VUVLX)

The growth versus value market cycle follows a pattern of long-term outperformance by one category followed by a flip that places the other category in the lead position. The rotation tends to revert to the mean approximately every 7-10 years. Fueled by low interest rates, the current growth-leading cycle that has encouraged investors to take greater risks has been in place since the financial crisis. It is now entering its ninth year. Investors have paid less attention to stocks with dividend yields and low P/E ratios.

While growth tends to outperform early in an economic cycle, investors turn to value stocks later in the cycle as growth becomes scarce. They are willing to pay higher prices for companies that are still growing their earnings. This is particularly true when overall expectations are low and actual results are slightly less than forecast. Investors stick with value stocks until late in the economic business cycle when these companies begin to face cyclical or structural headwinds and investors become more concerned about a slowdown or recession. Out-of-favor stocks have shown the ability to bounce back quickly after extended periods of underperformance because their strong absolute and relative returns are not erased over the long term. Overall, studies confirm that the value sector has outperformed the growth sector since the 1970s.

While value investing performs well over time, it can be difficult to stick with this strategy during extended periods of lower relative returns like those prevalent during the tech boom of the 1990s and the recent unprecedented prolonged bull market in growth stocks. The key is knowing when the tide is turning from one

category to the other. While the exact moment may be impossible to time accurately, value stocks tend to lead during periods of economic recovery or the normalization of activity. Value started leading growth in 2016, particularly after the election. This likely marks the start of a multi-year trend shift toward value.

The latest interest rate hike from the Federal Reserve is an attempt to normalize borrowing costs. Research shows that value stocks outperform after an initial rate hike, which may have occurred in December 2015. Value stocks also perform better during periods of rising commodity prices. The agreement to cut production at the latest OPEC meeting has strengthened oil as well as other commodity valuations. The period of record low interest rates, slower growth and lower earnings may be ending. These events may signal that the market is at an inflection point where expensive growth and defensive stocks may begin to weaken. Once the market shifts, investors may want to reposition their portfolios accordingly.

At this stage of the market cycle, it appears that value stocks are prepared to outperform the growth sector. Large-cap value mutual funds provide exposure to securities that are undervalued in terms of stock price due to temporary shortcomings in revenue or operational activities. Individuals can take advantage of these opportunities by investing in highly rated, well-managed mutual funds with strong track records and low expenses. Thus, investors who seek capital appreciation with a secondary objective of earning dividends should consider the Vanguard U.S. Value Fund (VUVLX).

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The Investor Guide to vanguard Funds

Fund Overview

Created in 2000, VUVLX seeks capital appreciation and income by investing substantially all its $1.5 billion in assets under management (AUM) in domestic common stocks that have been determined to be out-of-favor with the overall market. These value-oriented securities are selected based on a quantitative-driven approach to determine shares selling below their true market worth. While primarily focused on large-cap stocks, fund managers have the option to invest in mid- and small-cap shares as well. VUVLX is broadly diversified across numerous market segments. The five-star Morningstar rated fund strives to replicate or exceed the returns of the benchmark Russell 3000 Value Index.

Vanguard's 24-member quantitative team led by James Stetler, Michael Roach and James Troyer oversees VUVLX. Co-managing the fund since 2012, each fund manager has more than 15 years of experience with Vanguard. They oversaw the development of the team's screening process based on five factors that the managers believe will identify companies that will grow earnings faster than their industry peers. This earnings growth will then reward investors with an increased stock price. In addition to earnings growth, fund managers analyze momentum, valuation, quality, and management decisions.

The team believes momentum reveals underlying market strength that may not be readily apparent on a balance sheet. The current stock price is weighed against the company's true value. Analysts also gauge the valuation to ensure that the fund is not overpaying for earnings growth and is cheaper than the industry norm. Managers look for quality companies with strong economic moats, superior products, and strong balance sheets. Management decisions and changes may negatively affect prices

short-term but prove beneficial longterm.

While growth, quality and management rely significantly on the company's history and balance sheet, valuation and momentum are real-time market signals. Instead of equally weighting the five factors, fund managers use a dynamic approach. The analysis is adjusted to reflect factors unique to individual industries. For example, the team gives more credence to revenue growth rather than earnings when evaluating biotech stocks; it takes longer for sales to affect earnings in that industry. Once selected, stocks within the portfolio are overor underweighted by no more than 50 basis points compared to the underlying benchmark. Because the fund utilizes the Russell 3000 Index as its benchmark, it has a slightly higher small-cap tilt than the category average.

Portfolio Construction and Holdings

The fund managers' investment strategy means that they do not have to take oversized positions in a few shares to achieve the desired result. This creates a well-constructed portfolio. The fund has 253 individual holdings with 22.06 percent of AUM concentrated in the top 10 holdings. The largest holdings in descending order are Exxon Mobil Corp, JPMorgan Chase, Johnson & Johnson, Bank of America, General Electric CO. The next-largest holdings are Berkshire Hathaway, Citigroup, AT&T, Wells Fargo and Merck. Sector and stock diversification mean that there are few stocks with more than 3 percent exposure. The fund is also strategically positioned to capture upside potential during rallies while limiting downside during market sell offs.

With 97.3 percent of AUM in domestic stocks, the portfolio only has a 1.2-percent exposure to foreign shares,

primarily in developed Europe, and a 1.47-percent cash allocation. The fund has a 34.59-percent exposure to giant-cap shares as well as 19.11-percent and 24.33-percent allocations to largeand mid-cap stocks respectively. There is also a 15.16-percent investment in small-cap shares. Based on the benchmark index, the portfolio is overweight mid- and small-cap shares while being underweight giant- and large-cap shares. The average market capitalization of the fund is $22.4 billion compared to the category average of $55.4 billion.

VUVLX is overweight energy, financials, and industrials. These weightings should benefit the portfolio based on the current projected rise in oil prices, the increase in interest rates and President Trump's projected infrastructure projects. The portfolio is underweight consumer staples, real estate, and telecommunication services as well as utilities, which could be hurt by rising rates. The fund has P/E ratio of 18.7 and a price-to-book of 2.0 along with a turnover rate of 75.8 percent.

Historical Performance,

Risks, and Fees

Featuring a high dividend and a low tracking error of 1.67 percent, the actively managed VUVLX has outperformed its underlying benchmark for the past several years. The fund has also soared above its peers as its investment model has generated consistent alpha. Over the past one-, three- and five-year periods, VUVLX has delivered annualized returns of 24.37, 10.51 and 15.09 percent respectively. The comparable category averages are 13.88, 6.97 and 12.96 percent. The fund has a high return rating from Morningstar as well as an average risk rating. VUVLX has a three-year beta of 0.99, which is comparable to the category average, and a standard deviation of 11.22. This is

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The Best Vanguard Fund for 2017: Vanguard U.S. Value Fund (VUVLX)

slightly higher than the category average of 11.33. The fund's 0.23-percent expense ratio is significantly lower than the category average of 1.10 percent. The no-load fund has a minimum initial investment of $3,000. The most recent annual capital gains and dividend income distributions occurred Dec. 23, 2016. While capital gains were $0.2774 per share, the dividend was for $0.386 per share with a reinvestment price of $18.52.

Outlook

The fund has progressively improved its performance over the past five years. This trend should continue as value shares attract more investor interest. The fund's investment style enables managers to beat the underlying index without taking big risks. Its low management fee also makes it a compelling option. With its heavy domestic slant, the fund should benefit from the trade and tax proposals of the Trump administration. VUVLX also has a portfolio of safe buys that have performed well over the long haul. With a strong yield and excellent reinvestment potential, this mutual fund is recommended as a part of the dividend portion of a well-balanced portfolio for individuals with a long-term investment horizon.

Alternatives

Vanguard also offers the four-star Morningstar rated Value Index Fund (VVIAX). Like VUVLX, it offers a low-cost exposure to large-cap value stocks. The fund uses a replication in-

vestment strategy to track the returns of the underlying CRSP U.S. Large Cap Value Index. Large cap stocks are defined as the largest 85th percentile of the domestic market. In addition to its cost advantage, VVIAX offers low turnover and a well-diversified portfolio.

Fund managers select stocks from the less expensive, slower-growing half of the domestic large-cap market. Other evaluation metrics include projected earnings per share, sales per share growth and three-year historical earnings as well as current assets and return on assets. Stocks are then weighted based on market capitalization, which tilts the fund toward larger firms. While these firms may have lower return potential, they are also inherently less risky. The portfolio contains many wellknown household names like Microsoft, Exxon Mobile, Johnson & Johnson, General Electric and Wells Fargo.

VVIAX boasts one-, three- and fiveyear returns of 19.99, 10.22 and 14.94 percent respectively, which compare to the category averages of 17.95, 7.65 and 12.93 percent over the same periods. The large value fund has a 30-day Securities and Exchange Commission (SEC) yield of 2.53 percent. While the VVIAX has a minimum investment of $10,000, the fund also has an exchange-traded fund (ETF) class trading under the ticker symbol VTV.

Another alternative is the one-star Morningstar rated Vanguard Capital

Value Fund (VCVLX). Like VUVLX, this fund invests in stocks across all market capitalizations and tracks the Russell 3000 Value Index. Sub-adviser Wellington Management oversees the fund. Managers look for stocks that are deeply undervalued when compared to the overall market and have the potential for greater revenue growth. Evaluation metrics identify stocks that have a lower price-to-book ratio than firms contained within the underlying benchmark.

The fund has a tilt toward smaller, lower quality companies, which increases risk and volatility. The large value mid-cap blend fund contains one of Vanguard's most aggressive portfolios, which is light on defensive names and weighted toward cyclical firms that are more economically sensitive. While the fund does well in liquidity-driven, low-quality rallies, it captures more of the downside during selloffs, which lowers its risk-adjusted returns. Top holdings include MetLife, Citigroup, PNC Financial, Principal Financial and Raymond James.

This mutual fund has delivered one-, three- and five-year returns of 15.52, 2.76 and 13.26 percent respectively while the category averages over the same periods are 18.12, 6.85 and 13.58 percent. VCVLX has a 30-day SEC yield of 1.81 percent. Along with a high 134 percent turnover ratio, the fund has an expense ratio of 0.25 percent. There is a $3,000 minimum initial investment.

If you have any questions or comments about these funds, we would be delighted to speak with you. Please call us at (888) 252-5372, Monday through Friday 8:30am to 5:30pm, eastern time. You can also email me at Matt@.

mutualfundinvestorguide

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The Investor Guide to VANGUARD Funds

Vanguard U.S. Value Fund (VUVLX)

Top 10 Holdings Exxon Mobil Corp JPMorgan Chase Johnson & Johnson Bank of America Corporation General Electric Co Berkshire Hathaway Inc B

Citigroup Inc AT&T Inc

Wells Fargo Merck & Co Inc

% Assets 3.16 3.09 2.60 2.39 2.26 1.97 1.97 1.60 1.51 1.51

FUND CHARACTERISTICS

YTD Return 1 Year Average Annual Return 3 Year Average Annual Return 5 Year Average Annual Return

Morningstar Category Beta

Standard Deviation 30-Day SEC Yield

Turnover NAV

NET Assets Morningstar Overall Rating

Morningstar Risk Rating Investment Minimum Front / Deffered Load

Short-Term Redemption Period / Fee Expense Ratio Holdings

3.66% 24.37% 10.29% 15.09% Large Value

0.99 11.22% 2.08% 75.80% $18.98 $1.6B 5-Star Average $3,000

N/A N/A 0.23% 253

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Disclosure: Mutual Fund Investor Guide, LLC (MFIG) is an independent company unaffiliated with any of the fund companies discussed in this newsletter, including Fidelity Investments. These results include the reinvestment of all dividends and capital gains. Model trading does not involve financial risk; model trading cannot completely duplicate the financial risk associated with actual trading. MFIG is not an investment advisor and does not provide specific investment advice. This newsletter has been prepared solely for informational purposes. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. All investments involve risk including total loss of principal.

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