A couple of years ago I started meditating. Have you ever tried it for any consistent period? What are your thoughts; anyone out there attained enlightenment?
I’ve settled into a pattern of meditating 10 minutes around 4-5 times a week. I tried to create a daily habit but after a run-streak of over 250 days I forgot one day on vacation and now am much more relaxed about only doing it if I want to.
And do you know what I’ve found?
Look – it’s ok.
Meditation is pretty fine for me.
And what I do know is that I seem to drift back to meditating on a regular basis. I find 10 minutes works well for me and I look forward to my morning sessions. I honestly don’t know, or don’t possess the necessary self-reflection skills, to tell whether it’s doing me good. All I know is that I like doing it and it’s a peaceful period of nothingness in my day. Something we rarely have.
But you didn’t come here for nothingness – right?
You came here to dig into a totally weird Vanguard fund! Let’s get to work!
A Weird Vanguard Fund
Earlier this week I received an analysis of a client’s portfolio that held a Vanguard fund that I had not heard of, and moreover the expense ratio was listed as 1.8% (180bps!). I immediately sent it back to the analyst to correct the error as I was sure that a decimal point had been moved and the fee should have been something like 18.0bps.
It really has annual expenses of 180bps, over 45 times that of the flagship VTSAX fund!
You must be familiar with Vanguard? You know – those guys with the low-cost funds? Passive investment options? Simple and transparent funds? Yep, that’s the one.
Well this fund is none of those.
At 180bps it is high cost. And I don’t mean high relative to Vanguard funds, but high in the context of an actively managed equity fund. It’s got a fee level more in line with an exclusive hedge fund.
It’s also not passively managed, and it is neither simple nor transparent.
It’s definitely the black sheep of the Vanguard family.
Vanguard Market Neutral Fund (VMNFX)
The fund is the Vanguard Market Neutral strategy and they describe it as “a unique and complex investment approach, compared with other Vanguard funds. Its goal is to “neutralize,” or limit, the effect of stock market movement on returns. Because of this, the fund’s return is often uncorrelated to that of the stock market. Unlike other Vanguard funds, this fund uses long- and short-selling strategies”
There is a lot to unpack here, firstly what securities are in the fund, and how are they traded?
How Does It Work?
That’s pretty easy to answer, the fund invests in stocks, however it’s a mistake to think of it as an equity fund (confusing I know, but stick with me!). They don’t just buy stocks they also short-sell stocks. In this way they benefit if the stocks they buy go up, and benefit if the stocks they short go down. They also try to manage the aggregate buying and shorting so that general stock market movements cancel out. This is why it’s called “market neutral”. They only make money if the bets they’ve taken pay off, they don’t necessarily make money if the market just goes up.
It’s the total opposite of a passive fund. A passive fund bobs up and down driven by the level of the market. This fund is designed to just go up irrespective of how the market performs. At least that’s the theory!
For more details on passive funds see my post on The Cosmic Irony of Stock Picking Funds
These funds are sometimes called “absolute return” funds. Unlike a passive equity fund that can give you a positive or negative return depending on whether the stock market is up or down, this should give you a positive return most of the time.
Let’s see how it has performed.
Month-end (as of 07/31/2019)
Not very impressive is it? It’s produced a compound negative return over all periods except 10 years, and over ten years it has returned around 1% a year. At this point you might throw up your hands in disgust that a stocks fund has produced such a miserly return, after all VTSAX over the last ten years has returned 14% a year.
But remember that even though the fund is invested in stocks (long and short positions) it’s not designed to track the performance of the stock market. Really a better comparison is relative to cash. An absolute return fund should outperform cash and provide you with a real return net of fees.
Month-end (as of 07/31/2019)
Money Market Funds Average
From the table above you can see that over all periods except ten years it has under-performed cash and when taking the eye-wateringly large fee into account it underperforms cash over all periods.
So in terms of absolute returns I’m going to say it’s a total failure.
A part of the Vanguard blurb that I highlighted above trumpets the fact that returns are uncorrelated with the stock market. This is desirable behavior if you are looking to diversify your portfolio risks. If you could find a fund that performs well when stocks tank then that will give you some risk reduction and protect against sequence of returns in retirement (see Reprise! Sequence of Returns Risk, Introduction to Sequence of Returns and Buying a Boat in Retirement).
I could calculate a fancy correlation coefficient of returns, but sometimes it’s just easier to look at a chart. In the chart below I’ve plotted the quarterly returns of VTSAX (total stock market) versus the quarterly returns for the Market Market Neutral Fund (VMNFX) since 2009.
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The first thing to notice is that the Market Neutral Fund is much less volatile than pure stocks. You can see that the quarterly returns are pretty range-bound between +/-5%. It also looks fairly uncorrelated, there isn’t much of a pattern. However let’s look closer at the instances where equities tank. These are the points in the left-hand two quadrants. Of the 7 quarters where equities dropped, VMNFX also dropped in 4 quarters. And if you were to shift all the points down by 1.8% to take account of fees then VMNFX would drop in 5 quarters out of the 7 that VTSAX dropped.
In other words I would say VMNFX cushions against equity losses, but it certainly doesn’t zig when equities are zagging. When equities tank you cannot rely on this product to rally.
So based on this performance as a diversifier I think it has rather limited use.
Market Neutral Strategies
So I’m pretty down on this fund. It doesn’t seem to be worth the money to me.
However I’m not necessarily down on market neutral, or absolute return strategies. In fact I think they could be ideal strategies for the current, and future expected, market volatility. With rates plunging to zero (and beyond) and stocks in for a rocky ride wouldn’t it be great to find an asset class that provides a real return in excess of cash and is totally diversified to stocks and bonds? The way to view these strategies is capturing pure manager skill. There is no reason why skill should be linked to the performance of stocks and bonds if long and short positions are permitted. In this way it provides a pretty desirable asset class.
Market neutral promises promises much, but in the case of VMNFX it has not delivered.
What are your thoughts on this, are you looking for a for a market neutral fund? Perhaps not this one, but another one? Have you found an investment worth an annual management fee of 180bps? Any good meditation stories? Comment below!
Author Bio: I started actuary on FIRE as I did not see any actuaries taking a prominent role in the personal finance area and wanted to remedy a shortage of actuary jokes and write for those that appreciate rigor with fancy charts. In my regular day job I advise corporate US on investment and retirement strategies. I’m a qualified actuary, investment adviser and have a PhD in mathematics and reserve the right to have the occasional math post.