KISS: Keep it simple, stupid. The U.S. Navy’s design principle, dating back to the 1960s, says that systems work best if they are kept simple rather than complex. It may be boring, but the same applies to investment portfolios.
For the most part, Vanguard’s lineup of mutual funds and ETFs follows the KISS principle. In fact, Vanguard took a step toward simplicity last year by shutting down two of its more complicated funds—Managed Payout and Alternative Strategies. However, a few exceptions still exist. Today, I want to focus on those exceptions–Vanguard’s alternative funds.
In particular, I will analyze Market Neutral (VMNFX) and Commodity Strategy (VCMDX) in depth. Spoiler alert: I’m not a fan of either fund.
The best way to grow your wealth is to spend time in the market—owning productive companies that earn greater and greater profits over time. As I’ll explain, neither of these two funds fits that description: Market Neutral is a trading strategy, and owning commodities won’t compound your wealth over time like stocks.
First, though, a little housekeeping and a note on popular alternative assets.
Tidying House
While writing this analysis of Vanguard’s alternative funds, I took a fresh look at the IVA Performance Review table and decided to shift a few funds around.
First, I’m moving Real Estate Index (VGSLX) and Global Real Estate ex-U.S. Index (VGRLX) into the alternatives section. I wrote about real estate’s potential as an alternative asset here. You can also read about the foreign real estate fund here.
Second, I’ve moved Global Capital Cycles (VGPMX) into the international/global fund section. As I told you last November, since the fund’s reboot five years ago, it’s behaved more like a typical stock fund than an alternative.
These changes to the Performance Review table will go into effect at the start of June.
A Word on Gold (and Gold 2.0)
Since I know you’ll ask, let me touch on two of the most popular alternatives—gold and bitcoin—before getting to the funds.
Your options are limited if you are a Vanguard investor and want to own gold. Global Capital Cycles and Commodity Strategy are your best bets, but gold only plays a limited role in each fund. Frankly, you’ll probably end up owning a fund or ETF that doesn’t have the Vanguard imprimatur on the label.
As for bitcoin, as I discussed earlier this year, you won’t just have to buy a fund with a different label; you’ll have to take your money outside of Vanguard’s house if you want to own any cryptocurrency-related products.
I don’t spend much time discussing gold and bitcoin on these pages. (I know, I’ve talked about bitcoin several times this year, but it was big news for the investment landscape and Vanguard.) To me, investing means buying pieces of growing companies that can participate in and facilitate human progress.
Yes, I like to partner with active managers, but that’s mainly about focusing my dollars on companies on the upswing and the right side of history. I won’t try to talk you out of owning an index fund if that works for you.
I believe gold and bitcoin are not productive assets, so that’s not where I want to be invested over the long run.
Market Neutral: Sell
Can the good times continue?
That’s the question anyone considering Market Neutral must answer. But let’s start at the beginning.
Vanguard adopted this AXA Rosenberg-run fund in late November 2007. That partnership didn’t last long—Vanguard fired AXA in August 2010. This means the fund’s history before September 2010 (which stretches back to 1998) is irrelevant.
For years, Vanguard discouraged the average investor from purchasing Market Neutral by keeping the minimum hurdle prohibitively high at $250,000. Yet, in December 2014, Vanguard completely removed the minimum investment for investors working with financial advisers—though, as Vanguard puts it, “Given the distinctive characteristics of the fund…[it’s] not appropriate for retail investors broadly.” Apparently, that’s no longer the case, as Vanguard dropped the minimum to $50,000 in November 2019.
The promise of Market Neutral is alluring: deliver positive returns in bull or bear markets. The fund’s managers aim to do this by buying and selling short, in equal measures, the stocks Vanguard’s computers say look best and worst.
A “classic” example of this long-short approach is to buy Coca-Cola’s stock and sell Pepsi’s stock. It doesn’t matter if they both go up or down in value; you profit from this trade as long as Coca-Cola does better than Pepsi.
How does Vanguard decide which of Coca-Cola or Pepsi to buy and which to short? Vanguard uses a quantitative approach, which evaluates stocks on six different “models” or criteria: quality, consistency of earnings, momentum, valuations, how management makes decisions and how heavily shorted a stock is.
Also, in February 2023, Vanguard began using artificial intelligence (AI) alongside their “traditional” approach. I’ll let Vanguard describe it:
This AI approach relies on a proprietary deep-neural net architecture that was developed in-house to ensure that it preserves the fundamentals-driven approach we espouse while making our selection process sensitive to changing economic and market conditions.
The AI forecasts are blended with our traditional scores to generate an ensemble of daily stock rankings.
In other words, a potential drawback of a quantitative process is that it relies on stale, backward-looking data. Vanguard is now using AI to try and incorporate fresh economic and market data into its stock selection process. (Or at least that’s my best attempt at translating Vanguard’s description into English.)
That, in a nutshell, is how Vanguard tries to earn positive returns in every market environment—hence, the “market-neutral” fund’s name.
Of course, it’s easier said than done.