What would Jack Bogle think?
Vanguard’s legendary founder, who died three years ago at age 89, advised investors to avoid all luxury in their retirement portfolios, 401(k)s and IRAs.
Bogle’s usual advice to an ordinary investor was to stick to a low-cost US stock market index fund for long-term growth, such as Vanguard Total Stock Market Index Fund Admiral Shares VTSAX,
But here, little known and rarely mentioned, is Vanguard running what looks suspiciously like a hedge fund. And he is crushing it.
The Vanguard VMNFX Market Neutral Fund,
it even posted a small gain on Thursday, when the Dow Jones dropped 1,000 points and almost everything fell apart.
The fund was up a third of a percentage point on the day. (Nasdaq Composite Composite,
: 5% less)
The Vanguard Market Neutral Fund is up a stellar 9.5% year-to-date, despite stocks and bonds sinking. (The Vanguard Balanced Index Fund VBAIX,
which is 60% US stocks and 40% US bonds, has lost 12%).
And Vanguard Market Neutral is up an impressive 26% over the past 12 months, while the balanced fund is down 5%.
Amusingly, it’s also handily outperforming its expensive and exclusive hedge fund competitors. According to hedge fund index company HFRI, the average “stock market neutral” hedge fund has fared worse than the Vanguard fund for one and three years and year to date as well.
I was so intrigued by this non-Vanguard Vanguard fund that I called the company and ended up speaking with Matthew Jiannino, head of product management for Vanguard’s Quantitative Equities Group.
The first thing to note is that Vanguard is nervous about calling this a “hedge fund” because of all the connotations that phrase carries: high risk, etc. This is a regulated retail mutual fund, and the operating expenses are very low, very Bogle friendly, 0.25% a year. It does not use leverage and is intended to be “risk controlled,” Jiannino says.
On the other hand, if it looks like a duck, walks like a duck, and quacks like a duck, it’s probably a duck, and this fund is what the original, classic “hedged” funds looked like. It is “long-short”, which means that it bets on some stocks going up (“long” in trading jargon) and others going down (“short”). Jiannino says that the book is balanced, with bets on the upside and bets on the downside the same size, so performance is not correlated with stock indices.
The fund’s recent strong run follows a multi-year period in which it underperformed. Like many investors, he was left behind by the skyrocketing rise of big tech stocks in the late 2010s.
Jiannino says the fund typically makes positive bets on higher-quality names. You are not a “value” investor who only buys stocks relative to current fundamentals, but instead look for companies with good growth prospects that are trading at a reasonable price. “We tend to have a growth bias, but it’s a growth bias backed by quality,” Jiannino tells me. Stocks are selected by a small internal quantitative team, which apparently does a better job than most of the people at Ferrari in Greenwich, Connecticut.
Does this belong in a typical investor’s portfolio? Maybe not. In general, someone who wants more stability in their portfolio is advised to keep things simple and put some money into short-term bonds. Vanguard emphasizes that the Market Neutral fund is aimed at “sophisticated investors,” who might allocate “5 to 10%” of a portfolio to the fund. It can be helpful, especially at times like last year.
On the other hand, I note that the Market Neutral fund has produced a better 10-year return than the Vanguard Short Term Bond Fund VBIRX,
and especially so far this year. The fees are staggeringly low, the overhead ratio is over 1%, but it’s a somewhat misleading number that reflects the cost of short or “low” bets. Operating expenses are 0.25%.
I’d rather have this than most of those top hat hedge funds, who charge an arm and a leg and hand out bupkis. When he looks at the Vanguard fund, he wonders how those other managers get away with their fees.