Meet the little known Vanguard fund that’s crushing it—even in this market

What would Jack Bogle think?

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

Bogle’s usual advice to the ordinary investor was to stick to a low-cost U.S. stock market index fund for long-term growth, like this one

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

And it’s crushing it. The Vanguard Market Neutral Fund
even posted 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
: Down 5%.)

The Vanguard Market Neutral Fund is up a stellar 9.5% so far this year, even though stocks and bonds have both tanked. (The Vanguard Balanced Index Fund
which is 60% U.S. stocks and 40% U.S. bonds, has lost 12%.)

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

Hilariously, it is also handily outperforming its expensive, exclusive hedge fund competitors. According to hedge fund index company HFRI, the average “equity market neutral” hedge fund has done much worse than the Vanguard fund over 1 and 3 years and so far this year.

I was so intrigued by this un-Vanguard Vanguard fund that I called the company, and ended up speaking to Matthew Jiannino, head of product management for Vanguard’s Quantitative Equity Group.

The first thing to note is that Vanguard is edgy about calling this a “hedge fund,” because of all the connotations that phrase has about high risks and so on. This is a regulated retail mutual fund, and the operating expenses are a very low, very Bogley 0.25% a year. It does not use leverage and aims to be “risk controlled,” says Jiannino.

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 is “long-short,” meaning it bets on some stocks to go up (“long” in stock market jargon) and others to go down (“short”). Jiannino says the book is balanced, with the up bets and down bets of the same size, so that performance is uncorrelated with the stock market indexes.

The fund’s recent strong run follows a period of several years when it did poorly. Like many investors, it was left behind by the skyrocketing boom in big technology stocks in the late 2010s.

Jiannino says the fund typically makes positive bets on higher-quality names. It’s not a “value” investor that just buys stocks in relation to today’s fundamentals, but they are looking at companies with good growth prospects trading at a reasonable price, he says. “We tend to have a growth tilt, but it’s a growth tilt that’s backed up by quality,” Jiannino tells me. The stocks are picked by a small, in-house quantitative team, that apparently does a better job than a lot 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 things simple and put some money into something like short term bonds. Vanguard emphasizes that the Market Neutral fund is targeted at “sophisticated investors,” who might allocate “5 to 10%” of a portfolio to the fund. It can be useful, especially at times like the past year. The minimum investment is $50,000.

On the other hand, I notice the Market Neutral fund has produced a better 10-year performance than the Vanguard Short Term Bond Fund
and especially so far this year. The fees are astonishingly low, the headline expense ratio is over 1%, but it’s a somewhat misleading number reflecting the cost of the short or “down” bets. The operating expenses are 0.25%.

I would rather own this than most of those top hat hedge funds, which charge an arm and a leg and deliver bupkis. When you look at the Vanguard fund you wonder how those other managers get away with their fees.

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