Meet the little-known Vanguard fund crushing it even in this market

What would Jack Bogle think?

The legendary founder of Vanguard, who died three years ago at age 89, advised investors to avoid anything fancy in their retirement portfolios, 401(k) plans, and IRAs.

Bogle’s usual advice to the common investor was to stick with a cheap US stock market index fund for long-term growth, such as this VTSAX,
-3.70%

But here, little known and rarely talked about, Vanguard runs what looks suspiciously like a hedge fund.

And it crushes it. The Vanguard Market Neutral Fund VMNFX,
+0.33%
even made a small gain on Red Thursday, when the Dow fell 1,000 points and pretty much everything fell apart.

The fund was up a third of a percentage point for the day. (Nasdaq COMP,
-0.79%
: 5% down.)

The Vanguard Market Neutral Fund is up 9.5% so far this year, even as both stocks and bonds have fallen. (The Vanguard Balanced Index Fund VBAIX,
-2.56%
that’s 60% US stocks and 40% US bonds, lost 12%.)

And it’s up a staggering 26% in the past 12 months, while the balanced fund has lost 5%.

Hilariously, it also handily outperforms its expensive, exclusive hedge fund competitors. According to hedge fund index firm HFRI, the average “stock market neutral” hedge fund has underperformed the Vanguard fund over 1 and 3 years and so far this year.

I was so intrigued by this non-Vanguard Vanguard fund that I called the company and eventually spoke to Matthew Jiannino, chief of product management for Vanguard’s Quantitative Equity Group.

The first thing to note is that Vanguard is tense about calling this a “hedge fund” because of all the connotations that phrase has about high risk and so on. This is a regulated mutual fund for individuals and the operating costs are very low, very Bogley 0.25% per annum. It doesn’t use leverage and is intended to be “risk-driven,” 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 classic, original ‘hedged’ funds looked like. It’s “long-short,” meaning it bets on some stocks going up (“long” in stock market parlance) and others down (“short”). Jiannino says the book is balanced, with up and down bets of the same size, so performance doesn’t correlate with stock indices.

The fund’s recent strong run follows a period of several years of underperformance. Like many investors, it was lagged by the skyrocketing boom in major technology stocks in the late 2010s.

Jiannino says the fund typically makes positive bets on higher quality names. It’s not a value investor who only buys stocks relative to current fundamentals, but they look to companies with good growth prospects that trade at a reasonable price, he says. “We tend to have a growth side, but it’s a growth side that’s backed by quality,” Jiannino tells me. The shares are being picked by a small, internal quantitative team, apparently doing a better job than much of the Ferrari crowd in Greenwich, Conn.

Does this belong in a typical investor’s portfolio? Maybe not. In general, someone who wants more stability in their portfolio is usually advised to keep it simple and put some money in, for example, short-term bonds. Vanguard emphasizes that the Market Neutral fund is aimed at “advanced investors,” who may allocate “5 to 10%” of a portfolio to the fund. It can be useful, especially during times like the past year. The minimum investment is $50,000.

On the other hand, I notice that the Market Neutral fund has outperformed the Vanguard Short Term Bond Fund VBIRX over 10 years,
-0.30%
and especially so far this year. The cost is amazingly low, the total expense ratio is over 1%, but it’s a slightly misleading number that reflects the cost of the short or “down” bets. The operating costs are 0.25%.

I’d rather own this than most of those top hat hedge funds, which tax an arm and a leg and deliver bupki. Looking at the Vanguard fund makes you wonder how those other managers get away with their fees.

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