Vanguard Active Fund Manager dominates the market

How is smart money coping with Wall Street funk? For ideas on how to navigate a daunting bear market, check out Vanguard’s Sharon Hill.


Hill is an active fund manager. It’s a relative rarity at Vanguard. The popular fund complex is best known for its brigades of passively managed index funds. And as a stock picker, Hill can pick the brains of Vanguard research battalions.

Hill manages part of the $50 billion Vanguard Equity-Income Fund (VEIPX). Another part, or round, of the fund is managed by Matthew Hand. The hand is with sub-advisor Wellington Management. Hill and Hand run their respective rounds independently.

Additionally, Hill manages two similar Vanguard funds outside of the United States. One is available for UK investors, the other for Canadian investors.

At a group level within Vanguard, Hill is responsible for Alpha Equity Investments within Vanguard’s Quantitative Equity Group (QEG).

His team manages active global equity and income-oriented mandates using quantitative methods. More simply, it uses computers and programs to find stocks that generate income as well as growth.

Forward-thinking fund managers

Vanguard is well known for its low-cost, passively managed index portfolios. But in an effort to cater to a diverse market, the well-known family of funds based outside of Philadelphia also offers actively managed funds, such as Hill’s.

Vanguard’s QEG manages 20 US funds and 10 outside the US

In a complex known for near-benchmark funds, Hill’s overall mandate is the opposite. Its job is to find outperformance even if it is not within a single benchmark. The fund held 192 holdings as of June 30.

The Investor share class of its Equity-Income fund was down 2.89% this year to the end of July, compared to a 12.58% drop in the general market in the form of the S&P 500 and a decline of 6 .4% of its fund’s large-cap direct rivals. followed by Morningstar Direct.

Hill, 51, spoke about her approach to investing from her Vanguard office in Malvern, Penn.

Find leaders beyond your benchmarks

IBD: Describe your work, please, Sharon.

Sharon Hill: First, let me express my pleasure that you know that Vanguard does active management. We are a small piece in Vanguard. But we are completely active and are allowed to step out of our bearings and are encouraged to do so.

IBD: The word “quantitative” in your band’s title suggests that computer programs play a role in your band’s stock picking. How do you describe it?

Hill: Essentially, we are doing what a good fundamental manager does. A stock picker examines a company’s balance sheet. We code all of this in a template. And our model produces an opinion on every stock that we track every night. And we use an optimizer to build a portfolio that meets certain criteria. You can almost think it automates what a good fundamental manager would do.

IBD: But stock picking isn’t left to computers, is it?

Hill: Humans make the final decision on wallets. But these humans do it systematically.

How Dividends Underpin Success

IBD: Why do many leading industry-wide funds focus on high-dividend stocks? Is it because consistent dividend payers tend to be financially strong companies that have a good chance of surviving tough times and tough markets?

Hill: Now is the perfect time to be a dividend investor. This is finally the case after seeing high-flying growth stocks perform well for so many years.

Not only are we looking for dividend payers, but we’re looking for strong dividend payers who have strong payout ratios, strong balance sheets, strong cash flow, strong long-term track record of growing their dividends. And that should help us overcome this environment.

This gives us companies that have a very strong commitment to their dividend. Companies that haven’t cut dividends in 20 years are highly unlikely to do so. So it’s a good time to be in this type of business.

Stronger vanguard holdings

IBD: What are some of your most important holdings?

Hill: I don’t want to choose the good ones. But the one I love would be MGIC investment (MTG). (MTG’s two largest fund owners are Vanguard funds: $262.1 billion Total Market Index (VTSMX) and $41.3 billion Small Cap Index (NAESX), according to MarketSmith analysis. Neither neither is part of QEG, nor was MTG in Hill’s VEIPX as of March 31). It’s a mortgage insurance company. It was hit when rates started to rise. But it has a growing dividend (2.3% yield), a good payout ratio and a stable and solid return on equity (14%). Oh, and it has a reasonably attractive valuation, especially after rising rates gave (its stock price) a bit of a break.

IBD: What is another good example of stock highlighted by your process?

Hill: As quantitative investors, we tend not to think about individual stocks. Typically, quants just think about things in a broad factor exposure. But nevertheless, think of something like a Kroger (KR). (Grocery chain) Kroger has never cut its dividend. It’s only been buzzing for years. And it also has a decent valuation.

Not the sexiest stock, is it? But it fits into our process, given its stability, given its dividend history.

IBD: Is your fund doing anything to take advantage of rising interest rates?

Hill: Good companies are basically trying to get the last call at the bar. They borrow left and right before rates rise too much to fund dividends and buybacks.

IBD: Do you have an example?

Hill: Kroger is a stock with a strong buyback history. It has a long tradition of returning capital to shareholders, in addition to actively buying back its shares. The growth of its dividend exceeds 10%. And it has a solid payout ratio.

IBD: What part of your strategy should help you deal with inflation and a possible recession?

Hill: Our process is good for picking stocks. But we don’t necessarily believe we can choose sectors at this stage. So we tend to be fairly sector neutral. And when you go in and out of an inflationary environment, maybe a recession in an inflationary environment, the sectors tend to gyrate. We therefore believe that sector neutrality will help us avoid risks over this period.

IBD: The war in Ukraine is terrible for individuals. As an investor, what do you do if something reacts?

Hill: The impact on humans goes far beyond the wallet. There is unimaginable violence.

As an active manager, when the war started, we were talking about sanctions. We sold positions exposed to Russia. My portfolio is therefore not exposed to emerging markets.

In our global developed markets fund, we still have exposure to Russia through Evraz, a company that trades in London, a steel producer. We traded it. (After consulting his portfolio optimization model, Hill replaced Evraz with steel dynamics (STLD).). But my index fund friends who sit down the hall (at Vanguard) couldn’t get out. Their index hadn’t deleted it.

IBD: Has the fund taken other steps related to the war?

Hill: You can argue that alternative energy companies can benefit from this.

IBD: With such a highly automated process, what improvements does Vanguard expect to debut in the next 12-24 months?

Hill: We had the same (computing) model for most of the portfolios in the quantitative group. About three months ago we launched the specific equity income model. This is a model for stocks that pay dividends.

Right now the way we manage our models is to let humans choose the factors. But now we use machine learning techniques to choose the factors that go into our stock selection models.

Follow Paul Katzeff on Twitter at @IBD_PKatzeff for advice on retirement planning and actively managing consistently outperforming portfolios.


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