Most Tax Efficient Vanguard Funds April 11, 2014 Adviser Fund Update Print Vanguard Pushes Multimanager Button On March 31, Vanguard pushed its multimanager button once again, adding a third sub-advisory team, Pzena Investment Management, to its Selected Value fund, bringing the total number of named managers on the portfolio to seven.Pzena, which also manages a fund for non-U.S. investors and a portion of Vanguard’s Windsor and Emerging Markets Select StockA financial instrument giving the holder a proportion of the ownership and earnings of a company. funds, will initially build a portfolio from some of the fund’s current 5.8% cash allocation and be handed “a portion of new cash flow over time.” Firm Founder Richard Pzena will be joined by two co-managers, Eli Rabinowich and Manoj Tandon, in running the firm’s sleeve of the fund, following a classic, fundamental research-driven approach to the mid-cap value space. The new team’s initial impact on the portfolio will be small, leaving the lion’s share of Selected Value assets (about 70%) in the hands of original manager Barrow, Hanley, Mewhinney & Strauss, while Donald Smith & Co., added to the fund in 2005, will continue to oversee about 25% of assets. All told, Selected Value counts $8.5 billion in total assets, and is one of the few actively managed funds at Vanguard that has enjoyed consistent inflows over the last year, adding about $1.9 billion of net new cash in the past 12 months. Vanguard touted Pzena’s value investing experience and the additional diversificationA strategy for managing investment risk by investing in a mixture of different investments. Since different asset classes face different risks, even if one type of asset declines in value, others may not. multiple management teams bring to a fund as the reasons for the move. While we don’t think the addition is cause for immediate concern for investors, Adviser Investments does not share Vanguard’s fondness for the multimanager approach. We’ll be keeping a close eye on the fund, its portfolio and performance to see how the new structure is working. Tax Efficiency: Fidelity and Vanguard Funds In our last Adviser Fund Update, we discussed the effects of taxes on portfolio returns and covered some of the consensus thinking on asset placement. This week, we take a look at the tax efficiency of funds from Fidelity and Vanguard over the three years through March.Before we get into the data, it’s important to note that tax efficiency for funds is generally calculated in one of two ways. The first assumes you still own your shares at the end of the period, paying taxes on distributions along the way; this is the method we used to calculate the percentages you’ll see below. The second assumes that you’ve sold all shares, meaning that it also accounts for any additional short- or long-term capital gains you’ve realized since you bought the fund (tax efficiency will generally be considerably lower using this method if your investment has gained value). Because of Adviser Investments’ long-term investment philosophy, we think it’s more useful to look at the tax efficiency of funds you plan to hold on to. (When our clients are drawing down their accounts with us, however, we do consider how taxes will come into play when deciding what to sell, and together work out a plan that best meets each client’s needs.) Fidelity: Most and Least Tax-Efficient Funds Fund Symbol 3-Year Return Tax-Adjusted 3-Year Return Tax Efficiency Fifty FFTYX 15.2% 15.1% 99.4% Independence FDFFX 13.9% 13.8% 99.2% Growth Strategies FDEGX 10.4% 10.3% 99.2% Growth Discovery FDSVX 14.7% 14.6% 98.9% Select Electronics Portfolio FSELX 12.2% 12.0% 98.7% Select Biotechnology Portfolio FBIOX 38.7% 38.1% 98.5% Leveraged Company Stock FLVCX 13.5% 13.2% 97.7% Advisor Value Strategies FSLSX 12.7% 12.4% 97.6% Advisor Capital Development FDETX 12.0% 11.7% 97.2% Select IT Services Portfolio FBSOX 19.1% 18.5% 97.0% Total International EquityThe amount of money that would be returned to shareholders if a company’s assets were sold off and all its debt repaid. FTIEX 5.2% 3.9% 75.2% Real Estate Income FRIFX 9.5% 7.1% 75.0% Freedom 2000 FFFBX 4.1% 3.0% 74.8% Freedom Income FFFAX 4.1% 3.0% 74.7% International Value FIVLX 4.7% 3.5% 74.3% China Region FHKCX 5.2% 3.9% 74.2% New Markets Income FNMIX 7.5% 5.1% 67.8% Global Strategies FDYSX 4.2% 2.6% 61.9% Select Energy Portfolio FSENX 2.4% 1.1% 44.3% Emerging Asia FSEAX 0.7% 0.1% 7.5% Source: Morningstar. Note: Three-year returns are annualized. After-tax returns assume the highest applicable tax rate for each distribution and reinvestment of whatever’s left after taxes. Funds with losses over the period were excluded from the table. One thing that you might notice in the tables is that a handful of funds from each family have achieved excellent tax efficiency, but that their after-tax returns over the period were weaker than some of the funds that were less efficient. The starkest example of this is Vanguard Market Neutral, which let investors keep 99.4% of their gains after taxes on distributions, making it the firm’s most tax-efficient fund over the period. But unfortunately for investors, it only generated a 4.4% average gain per year while doing so. Compare that to the balanced Wellesley Income fund, which at 84.5% tax efficiency was one of the firm’s lower ranking funds. However, it still gained 8.1% a year after taxes, nearly twice Market Neutral’s return. Vanguard: Most and Least Tax-Efficient Funds Fund Symbol 3-Year Return Tax-Adjusted 3-Year Return Tax Efficiency Market Neutral VMNFX 4.4% 4.4% 99.4% U.S. Growth VWUSX 14.8% 14.7% 99.2% SmallCap Growth Index VISGX 13.6% 13.4% 98.8% MidCap Growth Index VMGIX 11.5% 11.3% 98.3% Admiral Tax-Managed SmallCap VTMSX 15.8% 15.6% 98.2% Strategic Equity VSEQX 17.2% 16.8% 97.9% Growth Index VIGRX 14.7% 14.4% 97.8% Windsor VWNDX 15.4% 15.0% 97.7% Extended Market Idx VEXMX 14.2% 13.9% 97.6% FTSE Social Index VFTSX 16.3% 15.9% 97.6% Wellesley Income VWINX 9.6% 8.1% 84.5% Pacific Stock Index VPACX 5.1% 4.3% 84.3% FTSE All-World ex-U.S. SmallCap Index VFSVX 4.9% 3.9% 80.8% Total Intl Stock Index VGTSX 4.3% 3.5% 79.5% FTSE All-World ex-U.S. Index VFWIX 4.1% 3.2% 79.1% LifeStrategy Income VASIX 4.7% 3.6% 75.6% Global ex-U.S. Real Estate Index VGXRX 6.6% 5.0% 75.4% Managed Payout VPGDX 8.2% 5.9% 71.9% Convertible Securities VCVSX 7.9% 5.6% 70.9% Energy VGENX 2.0% 1.0% 49.4% Source: Morningstar. Note: Three-year returns are annualized. After-tax returns assume the highest applicable tax rate for each distribution and reinvestment of whatever’s left after taxes. Funds with losses over the period were excluded from the table. You might also notice that there are no funds with negative returns listed. This is not because there weren’t any funds from the two firms that lost money over the period. (At Fidelity, seven funds were in negative territory over the three years through March: Select Natural Resources, Canada, EMEA, Emerging Markets, Global Commodity Stock, Latin America and Select Gold; while there were two from Vanguard: Emerging Markets Stock Index and Precious Metals and Mining.) We left these funds off of the list because investors had nothing to show at the end of the period, even though in every case they were stuck paying taxes on distributions, which resulted in negative tax efficiency. (A fund can also have negative tax efficiency if it has a positive pre-tax return that becomes a loss after taxes, though this did not happen at either fund family over the period covered in this update.) Looking at the numbers for both family’s stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. funds over the last three years, on the whole, they have been remarkably tax efficient. More than 50% of the Fidelity funds we included in our calculations (79 of 156) had a tax efficiency of 90% or better, while two-thirds of Vanguard’s funds (52 of 78) surpassed that mark. That’s pretty good, but those numbers may go down in the coming years as gains accumulated during the markets’ strong recovery since the market bottomed in March 2009 are realized and the funds have fewer losses on the books with which to offset them. If you own a fund not included in either of these tables and would like to see its after-tax returns, both Fidelity and Vanguard publish this information on their websites for a handful of different periods. You can find it by going to an individual fund’s “performance” page—both firms show after-tax returns before and after the sale of shares. To calculate tax efficiency, divide the after-tax return by the pre-tax return for a given period and multiply by 100. For example, if a fund has a 10.0% return before taxes and an 8.5% return after taxes, it was 85% tax efficient over that period. Tax efficiency is important, but it is just one consideration of many when selecting funds and managers to invest with. After a long period of gains, you may owe (or have paid) a sizeable amount in taxes, but in our experience, most investors are happier with more money in their pockets after taxes than holding onto tax-efficient investments that leave them with less after all is said and done. About Adviser Investments Adviser Investments operates as an independent, professional wealth management firm with expertise in Fidelity and Vanguard funds, actively managed mutual funds, ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index., fixed-income investing, tactical strategies and financial planning. Our investment professionals focus on helping individual investors, trusts, foundations and institutions meet their investment goals. Our minimum account size is $350,000. For the fifth consecutive year, Adviser Investments was named to Barron’s list of the top 100 independent financial advisers nationwide and its list of the top advisory firms in Massachusetts in 2017. We have also been recognized on the Financial Times 300 Top Registered Investment Advisers list in 2014, 2015 and 2016. For more information, please visit www.adviserinvestments.com or call 800-492-6868. Disclaimer: This material is distributed for informational purposes only. The investment ideas and expressions of opinion may contain certain forward-looking statements and should not be viewed as recommendations, personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed. Our statements and opinions are subject to change without notice and should be considered only as part of a diversified portfolio. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, riskThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. factors, strategies, affiliations, services offered and fees charged. Past performance is not an indication of future returns. The tax information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. We do not provide legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation. The Barron’s rankings consider factors such as assets under management, revenue produced for the firm, regulatory record, quality of practice and philanthropic work. This award does not consider client experience and is not indicative of future performance. Editors at the Financial Times bestowed “elite” status on 300 firms in the U.S., as determined by assets under management, asset growth, longevity, compliance record, industry certifications and online accessibility. © 2018 Adviser Investments, LLC. All Rights Reserved.