Vanguard : Fund managers focus on valuations amid volatility

A roundup of the latest Vanguard mutual fund reports

Note: To view the reports mentioned in this article, you'll need to have Adobe Reader installed on your computer.

Stocks have rebounded significantly from their late summer downturn. Although not robust, recent corporate earnings reports mostly surpassed expectations. Meanwhile, the U.S. Federal Reserve set the stage for a hike in short-term interest rates, and central banks in Europe and Asia signaled or implemented additional stimulus measures to counter sluggish growth and inflation. (In mid-December, after the close of the reporting period, the Fed raised its target for short-term rates to 0.25%.)

In the most recently published Vanguard fund reports, which cover the 12 months ended October 31, 2015, some of the advisors who manage Vanguard funds offered their insights into these global market and economic developments

Vanguard Explorer™ Fund (VEXPX), which focuses on small-capitalization growth stocks, is managed by eight different advisors. They bring a diversity of thought to the investment process as they manage their portions of the portfolio separately. There was some general agreement among a few of the advisors on the availability of investment opportunities in the small-cap growth segment.

'Since late 2014, market returns have slowly begun to more closely reflect growth rates and valuation,' wrote the four portfolio managers who manage the Granahan Investment Management, Inc., piece of the Explorer Fund. 'This bodes well for the portfolio's core growth and special situation companies, where visibility into management, business model quality, and long-term growth prospects should be properly rewarded. Such quality firms appear to be well-situated for the end of 2015 and 2016.'

Ryan E. Crane, Explorer's portfolio manager for Stephens Investment Management Group, LLC, delivered a similar yet succinct message.

'We expect to see ongoing volatility but also continued opportunity to invest in high-quality companies,' Mr. Crane wrote.

'Quality growth' and 'reasonable valuations' were also priorities at Century Capital Management, LLC, where Alexander L. Thorndike is Explorer's portfolio manager.

'In general, corporations remain well-capitalized and are increasing their earnings without the typical inflationary pressures that usually appear at this stage of a recovery,' Mr. Thorndike wrote. 'Investors hope the impending rise in interest rates will be slower and less disruptive than prior cycles. We believe a rate increase might benefit higher-quality growth businesses rather than more speculative industries such as biotechnology. As always, we remain focused on finding high-quality growth enterprises that we believe are trading at reasonable valuations.'

A look at emerging markets

Emerging markets were the poorest-performing market segment over the period. Chief among the issues have been China's slower economic growth, commodity price and credit woes in Brazil and other nations, and the decline in the value of emerging-market currencies as the U.S. dollar has appreciated.

Advisors for Vanguard Emerging Markets Select Stock Fund (VMMSX) offered their views on what has historically been one of the most turbulent portions of the market in their shareholder letters. The fund is managed by four advisors: Wellington Management Company LLP; Pzena Investment Management, LLC; Oaktree Capital Management, L.P.; and M&G Investment Management Limited.

'Decelerating global trade limits opportunities for smaller economies dependent on exports for much of their growth,' wrote Oaktree portfolio managers Frank J. Carroll III and Timothy D. Jensen. 'Slowing Chinese economic expansion contributed to weaker growth in demand for oil, metals, and other commodities just as advances in technology including shale oil extraction and large new mining projects were increasing supply. The extraordinary plunge in the price of oil led to serious disruptions in oil-dependent economies, including Russia. These factors hurt energy- and commodity-exporting economies in emerging markets more than the corresponding lower prices helped commodity importers, including China, India, and most other Asian nations.'

With the risk comes the potential for reward, which Pzena's three portfolio managers discussed in their letter.

'Although the last 12 months have been difficult for emerging-market investors, we are excited about current valuations and the continued broadening of opportunities,' the trio wrote. 'We are taking selective advantage of the situation to increase our exposure to high-quality franchises and strong balance sheets.'

A deuce of discipline

For the second straight month, Vanguard Chairman and CEO Bill McNabb encouraged shareholders to maintain their discipline through difficult market environments.

Investors who reacted impulsively and dumped all or most of their stock funds when markets tumbled in August and September wouldn't have participated in the gains that followed in October.

'As I've written in the past, the best course for long-term investors is generally to ignore daily market moves and not make decisions based on emotion,' Mr. McNabb wrote. 'This is also a good time to evaluate your portfolio and make sure your asset allocation is aligned with your time horizon, goals, and risk tolerance.

'The markets are unpredictable and often confounding. Keeping your long-term plans clearly in focus can help you weather these periodic storms.'

Other recently published reports:

Vanguard Global Minimum Volatility Fund

Vanguard International Explorer Fund

Vanguard International Value Fund

Vanguard Mid-Cap Growth Fund

Vanguard Municipal Bond Funds

Vanguard Selected Value Fund

Vanguard Windsor™ Fund

Vanguard Windsor II Fund

Notes:

• 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.
• Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.