Vanguard to Liquidate Billion-Dollar Fund
When is a billion dollars not enough? In Vanguard’s case, it’s when a $962-million fund “has not gained broad acceptance among targeted investors.”
On Jan. 3, the Malvern, Pa. fund titan closed its 32-year-old Vanguard Convertible Securities fund to new investors and plans to liquidate all assets in March. (Note that this is not a fund we currently recommend to Adviser Investments clients.)
The move will close the book on the strategy that helped turn value investor Howard Marks and his Oaktree Capital Management into a household name in the investment management world. Oaktree has been the fund’s sole adviser since 1996, and it remains a well-respected firm. The fund’s closure came as a surprise to many. After all, it has a competitive record compared to its Morningstar convertible bond peer group.
First, we’ll address why Vanguard said it was closing a fund that has “a capable advisor and prudent approach to managing convertible securities,” as described in its press release. Then we’ll explain what we think its actual rationale was.
Before that, though, a brief refresher on convertibles. These hybrid investment vehicles are structured like a bond and pay a periodic dividend, but can be “converted” into a stock at a predetermined price. Thus, they have the qualities of both stocks and bonds.
Essentially, convertible securities can function as a lower-risk investment for investors who generally prefer stocks or a stock-like investment for conservative investors.
Now, back to the closure. One reason Vanguard gave for the liquidation is that “investors could achieve similar risk-return exposures and long-term returns by investing in a diversified, balanced portfolio of global stock and bond funds.” This doesn’t pass our smell test.
We decided to compare Convertible Securities to Vanguard’s LifeStrategy Growth—a diversified portfolio of global stocks and bonds with a similar risk level to Convertible Securities—since Oaktree assumed management of the convertible fund. Convertible Securities outperformed the global diversified portfolio over that time, doing so with less risk. The notion that one can invest in a diversified, balanced, global portfolio and achieve the same results might be right… but Vanguard hasn’t done so.
On top of that, we doubt that many (if any) of Convertible Securities’ shareholders own the fund as a substitute for a more broadly diversified portfolio. It seems more likely that they own the convertible fund as part of their overall allocation, which is how Vanguard imagined institutional investors would use it.
Vanguard’s second explanation for closing the fund rings truer to us. It was established with pension funds, endowments and corporate non-profit retirement plans in mind and failed to catch on among those potential customers. Convertible Securities “remains one of the smallest offerings in terms of net assets among Vanguard’s stock and balanced offerings.”
There’s the rub. It’s all about size and scale.
Convertible Securities is simply too small for Vanguard to continue to operate it efficiently. And assets have been moving the wrong direction for years. As recently as 2014, the fund was twice its current size. Since then, investors have pulled more than $1.3 billion. That’s some considerable shrinkage.
Managing a fund with $962 million in assets would be a huge success for most investment firms. But for Vanguard? With some $5 trillion in assets and 171 other mutual funds and exchange-traded funds to administer, it’s like keeping track of pocket change.
The move also caused us to wonder about the long-term prospects of Vanguard’s other funds with less than $1 billion. Most in that category are relatively new and can probably expect plenty of runway to gather assets. One possible candidate for closure and absorption into another fund might be the Capital Value fund. It has “only” $800 million in assets, an iffy track record and a history of manager changes. That’d be an easy one to fold into Vanguard’s Windsor fund, given that the same manager works on both.
As for Convertible Securities, you’re out of luck. Existing shareholders can purchase additional shares until March 6, when it will be closed to new investments—but we’re not sure we see the point in adding money, since Vanguard is planning to turn around, sell off the portfolio holdings and return the proceeds to shareholders starting March 19. Any gains made in that short period will be taxable as income. After that, former investors will have a choice—find another convertible securities fund elsewhere, reinvest in one of Vanguard’s other options or find another use for their money.
So, rest in peace, Convertible Securities. The fund giant lumbers on…