PDF MUTUAL FUND Investor Guide THE Investor Guide TO VANGUARD FUNDS

MUTUAL FUND Investor Guide

THE Investor Guide TO VANGUARD FUNDS



Matthew D. Sauer Founder & Chief Investment Officer

Matthew Sauer is the Founder and Chief Investment Officer of the Mutual Fund Investor Guide family of newsletters. Each month he analyzes and provides buy, sell and hold recommendations for hundreds of mutual funds and ETFs in the Investor Guide to Fidelity Funds, Investor Guide to Vanguard Funds, as well as the ETF Investor Guide.

Prior to founding the Mutual Fund Investor Guide, Matt was the President and Chief Investment Officer of the Fidelity Independent Adviser, ETF Report, and Sector Momentum Tracker.

Matt Sauer earned his Juris Doctor from Albany Law School of Union University in Albany, NY. Mr. Sauer is a licensed attorney in the State of New York. He received his Master of Business Administration, from the State University of New York at Albany and his Bachelor of Arts in Political Science and Economics from Bucknell University.

SPECIAL REPORT:

The Best Vanguard Fund for 2016

Vanguard Equity Income Fund (VEIPX)

Vanguard Equity Income Fund (VEIPX) is a no-load mutual fund with $19.2 billion under management. Established in 1988, VEIPX has earned a five-star rating from Morningstar and seeks to provide reasonable long-term capital appreciation as well as above-average income comparable to the benchmark FTSE High Dividend Yield Index. The portfolio consists primarily of mid-, large- and giant-cap stocks that typically pay higher dividends. Investment managers choose stocks based on a commitment to paying those dividends consistently and focus on funds that are undervalued relative to their peers. The fund's multiple advisors invest at least 80 percent of assets in domestic and foreign equities.

Investment Strategy

In its effort to achieve above-average dividend income and reasonable long-term capital appreciation, the fund utilizes the services of two investment management groups: Vanguard's in-house management led by James Stetler, who uses quantitative investment techniques to analyze company fundamentals, and the Wellington Management team, led by Michael Reckmeyer, which uses a more traditional bottom-up approach. The Vanguard team manages approximately one-third of total assets, while Mr. Reckmeyer oversees the remaining twothirds of the fund's assets under management.

Both teams attempt to find value during market pullbacks and then hold for the long term. Reckmeyer's contrarian approach looks for out-of-favor stocks with above-average dividends, low valuations and healthy balance sheets as well as unappreciated growth prospects. Reckmeyer tends to hold stocks between four and five years, though he will sell on pre-

determined targets or should a company fundamentally deteriorate or a similar company exhibit better valuations. Reckmeyer is also not hesitant to use multinationals, such as Unilever, that pay strong dividends and earn wide Morningstar Economic Moat Ratings.

Mr. Stetler and his Vanguard team of analysts use computer models to select stocks based on valuation, growth, momentum and earnings sustainability, fusing that data with management decisions such as stock buybacks and dividend increases. Although the portfolio turnover is higher than that of the Wellington team, it is still below category averages. Reckmeyer deviates from the underlying benchmark by as much as 10 percent in a given sector, while the Vanguard team stays relatively close to the sector weightings of the underlying benchmark. Stetler sold the fund's stake in Apple when the stock was dropped from the FTSE; the company's yield no longer met the requirements for inclusion in the index.

Portfolio Composition and

Holding

VEIPX had a 90 percent exposure to domestic equities and an 8 percent allocation to foreign shares, evenly split between the United Kingdom and developed Europe, as of October 31, 2015. The fund held 2 percent of assets in cash. In addition to a 64 percent exposure to giant-cap shares, the fund held 25 percent of its assets in large-cap stocks, 9 percent in mid-caps and 2 percent in small-cap shares. The portfolio's average market cap weighting was $74 billion, compared with the category average of $82 billion. The fund had a P/E ratio of 19.0 and a price-to-book ratio of 2.5.

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The Investor Guide to vanguard Funds

The fund holds 176 individual issues, incorporating more diversification than most of its income-oriented peers. Relative to its benchmark, the FTSE High Dividend Yield Index, the portfolio is overweight utilities, industrials, healthcare and financials and is underweight telecom, materials and consumer staples. Of these, the most overweight position is financials, at 17.2 percent of assets, 2.6 percentage points above the benchmark. Since the Federal Reserve has begun an interest rate hike cycle, financials should outperform the broader market in 2016.

Investors may also want to consider VEIPX weightings versus the S&P 500 Index. The high-yield fund is unsurprisingly underweight technology at 14.10 percent of assets, more than 6 percent below the weighting in the S&P 500, while financials are slightly overweight. Healthcare is roughly 3 percentage points underweight, and consumer discretionary accounts for half the weighting of the S&P 500 Index. Utilities are overweight at 8.6 percent of VEIPX, versus 3 percent in the S&P 500. Although utilities are likely to drag on performance in 2016 due to higher interest rates, VEIPX is not relying on the sector for yield.

The top 10 holdings in VEIPX comprised almost 30 percent of total assets as of November 30. In descending portfolio weight, they include Microsoft (MSFT), Wells Fargo (WFC), JPMorgan Chase (JPM), Johnson & Johnson (JNJ) and General Electric (GE), followed by Merck (MRK), Intel (INTC), Exxon Mobil (XOM), Verizon (VZ) and Home Depot (HD). The fund has a below-average 32 percent annual turnover. Several of the top 10 holdings, including Wells Fargo, J.P. Morgan, Johnson & Johnson, Verizon and General Electric, have been in the portfolio for more than a decade.

Microsoft was recently featured in Barron's, which sees good upside for the company in 2016. CEO Satya Nadella has shifted the company into cloud-re-

lated services since taking over in 2014, and the firm is now hitting its stride as these efforts pay off. The firm is reasonably priced with a solid 2.7 percent dividend, even if it fails to strike it rich with some of its latest products.

General Electric recently spun off its Synchrony (SYF) consumer finance arm and will plow the cash back into the firm. The company recently purchased the power generation business of Alstrom in France, its largest industrial investment ever, in an effort to return to its industrial roots.

Finally, financials remain a strong value play in light of improving fundamentals such as rising interest rates, but the real strength may lie in latent dividend potential. Regulators forced banks to slash payout ratios in the wake of the 2008 crisis. Recently, banks have pressed regulators to ease these restrictions, and while there's no knowing if or when regulators might ease the rules, payouts are already rising with profitability. Financials were abandoned as income investments when banks cut or eliminated dividends in 2008, but investors surely will return if dividends begin growing at a faster clip.

Expenses, Fees and

Distribution

The Vanguard Equity Income Fund does not charge initial, deferred or redemption fees. There are also no 12b-1 fees. The fund's 0.29 percent expense ratio is 74 percent lower than the category average. Fees vary as Vanguard pays Wellington Management an asset-based fee with breakpoints and a performance adjustment.

An initial $3,000 investment applies to both taxable and nontaxable accounts, with no subsequent investment minimum. VEIPX pays a quarterly dividend as well as an annual distribution of short- and long-term capital gains. The most recent quarterly income distribution on December 17, 2015, was $0.251 per share with a reinvestment price of $29.88. The annual capital gains distribution in December 2015 included a short-term capital gains payout of $0.216 and a long-term capital gain of $0.800 per share. Those capital gains were equivalent to 3.4 percent of the net asset value.

Historical Performance

VEIPX has earned an average return rating and a below-average risk rating from Morningstar. General Electric's $18.68 52-week price change and Home Depot's $33.95 jump contributed mightily to the fund's total returns. As of the end of November 2015, the fund had delivered total 1-, 3- and 5-year returns of 1.14 percent, 14.42 percent and 13.84 percent, respectively, compared with large-value category average returns over the same periods of -3.69 percent, 12.71 percent and 10.63 percent.

Returns (as of 11/30/15) VEIPX

1-year (%) 1.14

3-year (%) 5-year (%)

14.42

13.84

Category Average

-3.69

12.71

10.63

VEIPX has lagged the S&P 500 over the past 1- and 3-year periods despite beating category averages. The fund slightly outperformed the market over the past 5 years and consistently produces an above-average yield compared with Morningstar's large-value category averages. As of December 23, 2015, VEIPX had a 2.8 percent 30-day SEC yield.

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The Best Vanguard Fund for 2016: Vanguard Equity Income Fund (VEIPX)

Outlook

The fund managers' consistent leadership, complementary investment styles and proven long-term results have earned VEIPX a Silver analyst rating from Morningstar. Although the fund tilts toward large-caps, which may underperform small-caps in a bullish market, fund managers have demonstrated an ability to find and add value with less volatility. During weaker markets, such as we saw in 2015, the value and largecap approach has paid dividends and empowered the fund to best its smaller-cap competition.

VEIPX should continue to deliver competitive results while keeping fees, expenses and risks in check. The fund is suitable for investors with long-term goals seeking current income who can also tolerate short-term market volatility.

Other Considerations for 2016

Vanguard Global Minimum Volatility (VMVFX)

Vanguard Global Minimum Volatility (VMVFX) is designed to achieve lower volatility than its benchmark while offering currency hedged global equities exposure against its benchmark, the FTSE Global All Cap Index Hedged.

VMVFX prioritizes minimum volatility; beating the benchmark is always a plus, but the fund is more likely to sacrifice higher returns to minimize risk. VMVFX has beaten its benchmark by 4 percentage points since inception at the end of 2013, though more aggressive investors will still want to investigate higher-yield options.

VMVFX also offers investors a hedge against foreign currency exposure. Since the U.S. dollar bull market kicked off in July 2014, owning a currency hedged fund has been lucrative. The World Stock category tracked by Morningstar over the past two years has gained 2.79 percent and 0.21 percent in 2015. VMVFX has gained 13.74 percent and 7.52 percent, respectively. The U.S. dollar remains in a bull market that should carry the greenback to new highs in 2016.

VMVFX has an expense ratio of 0.30 percent. Investors with at least $50,000 to invest can opt for Admiral shares (VMNVX) for a lower 0.20 percent expense ratio.

Vanguard U.S. Value (VUVLX)

The financial sector is poised for success in 2016, and rising interest rates and economic growth portend growth for banks. VUVLX is well positioned to benefit, with 30.7 percent of assets in the sector as of November 2015.

The fund focuses on large- and mid-cap value stocks perceived by management to be out of favor with the general market. These stocks may also incur higher-than-average dividend yields and lower-than-average price/earnings ratios. As with VEIPX, the VUVLX management team uses proprietary software and a quantitative investment approach to identify stocks that balance strong growth with reasonable valuations when compared with industry peers. Managers construct the portfolio from stocks selected primarily from the Russell 3000 Value Index. While the fund typically concentrates on undervalued large- and

mid-cap companies, it has no strict size restrictions. The fund may invest up to 20 percent of assets in foreign securities and engage in currency hedging strategies associated with those investments.

VUVLX currently yields 2.1 percent with an expense ratio of 0.29 percent.

Vanguard Dividend Appreciation (VDADX) (VIG)

Dividend Appreciation provides a perennial go-to option for investors looking for income growth. The fund comprises companies that combine earnings growth, low payout ratios, and strong balance sheets to weather recessions and financial crises. Dividend Appreciation has a good track record, earning it a three-star rating from Morningstar. It tends to underperform slightly during bull markets, but it has outperformed in bear markets, as in 2008, as these financially solid companies are less likely to cut their dividends. Investors hold these stocks for the long term, through thick and thin, leading to solid performance and less volatility. The fund currently yields 10 percent over the S&P 500 Index, so investors won't sacrifice yield in order to hold companies with stronger financials and better dividend growth prospects. This ETF currently yields 2.26 percent and is low cost, charging only 10 basis points.

If you have any questions or comments about these funds, we would be delighted to speak with you. Please call us at (888) 252-5372, Monday through Friday 8:30am to 5:30pm, eastern time. You can also email me at Matt@.

mutualfundinvestorguide

mutualfundIG

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The Investor Guide to VANGUARD Funds

TOP TEN HOLDINGS (as of 9/30/15)

Company Name

Symbol

Initial Purchase Date

Microsoft Wells Fargo J.P. Morgan Chase Johnson & Johnson Verizon Merck General Electric Exxon Mobil Cisco Home Depot

MSFT WFC JPM JNJ VZ MRK GE XOM CSCO HD

9/30/2008 3/31/1999 9/30/1998 3/31/1999 12/31/1995 12/31/2009 12/31/1995 12/31/2009 9/30/2012 3/31/2007

TOP TEN HOLDINGS TOTAL

% of Assets

4.2 4.0 3.3 2.8 2.7 2.6 2.5 2.5 2.3 2.2

29.1

FUND CHARACTERISTICS

1 Year Return 3 Year Average Annual Return 5 Year Average Annual Return 10 Year Average Annual Return Since Inception Average Annual Return

Morningstar Category 30-Day Yield % Turnover NAV Net Assets

Overall Morningstar Rating Investment Minimum/Required Balance

Front/Deferred Load Expense Ratio

Short-Term Redemption Period/Fee

0.79% 14.52% 13.17% 8.08% 10.09% Large-Cap Value 2.81%

32% $30.03 $19.3 Billion 5 Stars $3,000 None 0.29% None

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Disclosure: Mutual Fund Investor Guide, LLC (MFIG) is an independent company unaffiliated with any of the fund companies discussed in this newsletter, including Fidelity Investments. These results include the reinvestment of all dividends and capital gains. Model trading does not involve financial risk; model trading cannot completely duplicate the financial risk associated with actual trading. MFIG is not an investment advisor and does not provide specific investment advice. This newsletter has been prepared solely for informational purposes. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. All investments involve risk including total loss of principal.

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