Think back to 1959. The United States was expanding from 48 to 50 states with the inclusion of Alaska and Hawaii. Gas cost a quarter per gallon. A brand new Ford car would set you back $2,000. The Boeing 707 was first mass produced. American commercialism was falling in love with Mattel’s new Barbie doll creation, becoming the most sought after Christmas gift for young American girls. And in Cuba, Fidel Castro—boo, heckle heckle—was rising to power.
Also of interest, but rarely discussed, was the birth of one of America’s stodgiest Vanguard mutual funds that receives almost no attention but has nevertheless delivered exceptional risk-adjusted returns and made any long-term fundholders rich. I am referring to the rarely analyzed Vanguard U.S. Growth Fund (VWUSX). It’s funny—Vanguard has correctly earned a reputation as the powerhouse of the passive investing industry, but it has quite a few actively managed funds that serve as testaments to the advantage of developing the discipline to pick and choose a collection of individually assets with above-average growth characteristics.
In the case of Vanguard U.S. growth, the fund has delivered 10.46% annual returns since its inception date on January 6, 1959. It’s one of the best long-term investing success stories imaginable, as a $10,000 investment in the fund would have grown to $4.6 million over the past fifty-nine years. And get this, if you had consumed all dividends and distributions, you would have picked up $450,000 in cash payouts over the years and you’d still have an asset worth $2.7 million. That both reflects the importance of reinvesting generated cash, while also showing how the compounding continues even as you start to harvest from the investments that you sow.
How did a mutual fund from a buttoned-up fund house manage to deliver such excellent returns? By recognizing the scalability advantages of information technology. It owned big slugs of IBM stock in the 1960s, and over the past decade, has loaded up with shares of Alphabet, Visa, Mastercard, Paypal, and eBay.
This is a fund that has lived up to its name. Normally, we understand the dichotomy between “growth investing” vs. “value investing” to mean that growth investments rely on sharp increases in earnings and revenues whereas value investing involves finding stocks that are cheap and making money to the point where that ceases to be the case.
The inherent advantage of growth investing is that, upon the correct identification of a fast-growing investment, the investor can sit back for years on end and the rewards pile up. This is in comparison to the value investor, who, upon the completion of an investment’s shift from undervaluation to fair valuation, may need to sell the stock as the basis for the outperformance has dissipated. Typically, the only drawback is the need to have the emotional discipline to tolerate unusually high fluctuations in the quoted market prices.
And it shows in the numbers. From 1959 through 2010, the average turnover rate for this fund was 17%. This means that each stock selected for the U.S. Growth Fund’s portfolio remained in the fund’s account for approximately six years. The turnover rate has drifted north of the 25% mark in recent years, implying an average holding period of roughly four years. This still compares favorably to the astonishingly low average holding period for a mutual fund that is now less than six months per investment.
As currently composed, many of the VWUSX holdings consist of overpriced growth stocks. This does not necessarily mean that poor performance lies ahead. While the average P/E ratio of the fund holdings sits at around 30x earnings, the constituent parts are growing earnings 15% per year. I anticipate that the record of 10% annual returns will more or less continue, as the current holdings consist of fast-growing yet overpriced investments that ought to deliver 8-10% annual returns when the P/E compression drags down the earnings per share growth a bit.
The most significant risk for investors in this fund is that it comes with more volatility than you’d typically expect from a billion-dollar Vanguard Fund. Its reliance on investments with high earnings per share growth mean that it has contained holdings with very high P/E ratios, and when the compression inevitably happens, the whacking comes hard. It traded at $49 in 2000, and fell to $12 in 2002. It would be foolish to pretend that something which has happened once before cannot happen again.
Opportunistic long-term investors would consider waiting for some type of damper of enthusiasm in the world of tech stocks before making a large lump-sum investment. Otherwise, making regular contributions of several hundred dollars per month, gradually accumulating shares over time, is likely the preferred approach with this fund holding. It is interesting to me that Vanguard spends so much advertising their passive funds when their actively managed funds have demonstrable track records of success and generate the lion’s share of compensation for the firm.