Fund Spotlight: Vanguard Morgan Growth Fund

The wide variety of options for growth-minded investors can be daunting; less flashy funds tend to be overlooked. Individuals looking for an actively managed growth fund that invests in mid- and large-capitalization companies should consider the four-star Morningstar rated Vanguard Morgan Growth Fund (VMRGX). We like this underappreciated choice, which offers a unique blend of sector and growth exposure where many comparable funds fall short.

Growth funds offer opportunities for capital appreciation that increase the value of both the fund and individual portfolios. They also provide exposure to a broad range of stocks, which helps to reduce volatility and risk. Professional portfolio managers and their supporting analysts have the ability to scan the entire investment horizon and identify stocks with the best growth potential that also fit the investment strategy of the fund, a process that can be difficult for individual investors. A growth fund creates a passive way to invest in a diversified grouping of stocks poised for capital appreciation.

Mutual Fund Profile

The highly diversified $10.88 billion Vanguard Morgan Growth Fund invests at least 80 percent of assets in domestic large- and mid-cap stocks that managers believe are poised to generate faster-than-average earnings and revenue growth. This large-growth category fund may also invest in preferred shares, convertible securities and warrants. Up to 25 percent of assets may be invested in foreign stocks. VMRGX employs an active strategy that incorporates the distinctive investment approaches of five sub-advisors. The fund’s mid-cap holdings potentially increase volatility more than if the fund were concentrated strictly on large-cap shares. This no-load, non-diversified mutual fund has an initial investment minimum of $3,000.

Investment Strategy

The fund’s sub-managers utilize traditional, fundamental bottom-up research approaches and one quantitative analysis approach to stock selection. In addition to capitalizing on multiple individuals’ strengths, the multimanager structure ensures broader diversification while reducing potential volatility. The managers include:

Jim Stetler, pincipal of Vanguard, aims to outperform the MSCI U.S. Prime Market Growth Index by using a multifactor computer stock-picking model.

Paul Marrkand, Senior Managing Director and Equity Portfolio Manager at Wellington Management, oversees the largest tranche of VMRGX. His primary focus is on large-cap stocks whose price he believes does not reflect the companies’ competitive advantages and earnings potential. As we have mentioned in previous newsletters, he is a fantastic manager.

Kathleen McCarragher, Managing Director and Head of Growth Equity at Jennison, concentrates on large-cap companies that are growing revenues faster than the S&P 500.

Ford Draper, President, Chief Investment Officer and founder of Kalmar, as well as Stephen Knightly, CFA, President of Frontier Capital, concentrate on smaller stocks, utilizing many of the same analytical tools as their fellow managers while also taking into consideration such factors as growth, value and earnings momentum.

Portfolio Composition and Holdings

The portfolio is spread across 348 individual stocks (as of June 30). Apple (AAPL) comprises 5.4 percent of the fund, more than double the allocation to the second holding, Google (GOOG). This makes for a relatively diversified fund with less than 20 percent of total assets in the top 10 holdings. Other major holdings include Gilead Sciences (GILD), Amazon (AMZN), Facebook (FB), Oracle (ORCL), Microsoft (MSFT), Biogen (BIIB), Home Depot (HD) and Bristol-Myers Squibb (BMY). Other significant holdings generate a solid exposure to biotechnology, including Amgen (AMGN), Allergen (AGN), Celgene (CELG) and BioMarin (BMRN).

The fund has a 93 percent allocation to domestic shares and a 5 percent exposure to non-U.S. securities, primarily from Developed Europe. VMRGX has an average market cap of slightly more than $44 billion, which is $10 billion less than the benchmark Russell 3000 Index due to its small- and mid-cap exposure. The portfolio has 41 percent exposure to giant-cap funds as well as 33 percent allocation of large-cap shares, though the fund also has 24 percent and 2 percent exposure to mid- and small-cap shares, respectively. These allocations are roughly in line with the benchmark index, but the fund is about 6 percent underweight giant-caps, with that exposure shifted mainly to mid-caps and some in small-caps. The portfolio has a price-to-book of 4.12 and a P/E ratio of 22.02 as of June 30.

Historical Performance and Risk

VMRGX is overweight healthcare, consumer discretionary and technology, which are three of the four top-performing sectors in 2015. It is underweight energy and materials, two of the worst-performing sectors this year. The Vanguard Morgan Growth Fund has an above-average return rating from Morningstar.

VMRGX has increased risk due to its heavy concentration in three sectors (about 75 percent of assets as of August 31), but that concentration has paid off in 2015. Although shares underperformed the S&P 500 Index in late September and early October due to weakness in healthcare, year-to-date through September 30 VMRGX was down 0.20 percent versus a 5.29 percent drop in the S&P 500.

The fund has managed long-term risk well, with an average risk rating from Morningstar as well as a 3-year beta and a standard deviation of 1.02 and 10.34, respectively. These compare to the category beta and standard deviations of 1.02 and 11.01.

Fees, Expenses and Distributions

VMRGX has an expense ratio of 0.40 percent. This is significantly less than the category average of 1.18 percent. The fund does not have a 12b-1 fee. On December 17, 2014, the fund had a short- and long-term capital gain distribution as well as a dividend payment totaling $3.016 per share with a reinvestment price of $24.86. Investors may want to consider holding this fund in a tax-efficient account.

Outlook

Depending on how investors view the risk/reward opportunities in the healthcare, consumer discretionary and technology sectors, VMRGX may be a good option that reduces portfolio exposure to commodity sectors. VMRGX typically beats the performance of more than 70 percent of its category peers. The fund also benefits from Vanguard’s economies of scale, which produce lower-than-average fees and expenses for an actively managed fund. Vanguard Morgan Growth Fund may be a suitable portfolio addition for investors with a moderate risk tolerance and a long-term investment horizon. Currently, we rank the fund as a Strong Buy with a ranking of 88.