Should You Applaud Vanguard’s Move To Close Its Active Dividend Growth Fund?

I recently read the following announcement from Vanguard:

Vanguard Dividend Growth Fund (VDIGX) is closed to new investors as of July 28, 2016. The fund will remain open to existing investors for additional purchases

“Vanguard is proactively taking steps to slow strong cash flows to help ensure that the advisor’s ability to produce competitive long-term results for investors is not compromised,” said Vanguard CEO Bill McNabb. “We have long been committed to protecting the interests of our funds’ shareholders, and demonstrate this conviction by closing or restricting funds to stem further growth.””

I do not envy those of you who are starting your journey in 2016, because I agree with the basic premise that many dividend stocks are expensive.  The ones that appear cheap may have some potential issues with them (e.g. – being cyclical or being in an industry where fundamentals are expected to crumble). It is a decent idea to hold those stocks probably if you have a 10 – 20 – 30 year investment horizon and nerves of steel, but probably not a good idea to buy at current valuations. I would have applauded Vanguard if the closing of that active fund was all to it, as I somewhat agree with their basic premise.

Vanguard Investments dividend fund

However, the end of the press release had the following information, which negated the whole goodwill of “saving investors” in the first place.

If you’re interested in seeking a similar fund that invests in high-quality companies with a history of increasing dividends, you may wish to consider:

Vanguard Dividend Appreciation Index Fund (VDAIX), which is passively managed and seeks to track the performance of a benchmark index that measures the investment return of common stocks of companies that have a record of increasing dividends over time.”

I actually find it funny that people have chosen to applaud Vanguard’s move without thinking about it ( or looking at the data). This shows how much people focus more on the ideology part of it by default, and not really thinking about it. To paraphrase Charlie Munger, you should not let yourself be brainwashed by ideologies, but should maintain an open but skeptical attitude to ideas.

The fund that is being closed is an “actively managed” dividend fund (VDAIX). According to Vanguard, the average P/E is 21.70. The fund has $30 billion in assets. This fund has turned $10K into over $23,688 over the past decade. Source: Vanguard

However, in the press release announcing the closing of the fund to new investors, Vanguard clearly states that the “passive index” dividend fund is still going to be open to new investors. According to Vanguard, the average P/E for the passive fund is 24. The fund has $26 billion in assets. This passive fund has turned $10K into over $21,114 over the past decade. Source: Vanguard

Here lies the irony of the situation – Vanguard ( which is passive investment pioneer) chooses to close the active dividend fund to protect investors against overvalued equities, but keeps the passive dividend fund open. The passive fund has a lot of the same stocks as the active one, but the former has a more expensive portfolio on average.

I like the fact that Vanguard has revolutionized investing and lowered investing costs for millions of savers in the US and throughout the world. I have learned a lot from Vanguard founder Jack Bogle that investment costs matter and should be minimized. Jack Bogle also taught me that dividend income is more stable and more reliable than capital gains. In fact, one of his first books I ever read valued the stock market in terms of the Price to Dividend Ratio.  I also like his thoughts on the fact that owning US multinational stocks provides sufficient global diversification to the US investor, since a large portion of those revenues are generated from abroad ( without the hassle at the investor level of foreign withholding taxes, currency fluctuations, learning foreign accounting, etc)

After looking at the data however, I do not believe that Vanguard should get any praise for this hypocritical move. And no, I am not saying that because I “hate” indexing – I am maxing out my 401 (k) entirely with index funds this year, but spend my dividends and other passive income for living expenses. Anything left over in taxable accounts just goes to be invested in individual dividend paying stocks.

This move actually reinforces the observation that people invest passively without regards to valuation – which could lead to poor returns over time if you buy overvalued shares. Apparently, people who invest “actively” had a fail-safe switch and some safeguards. At the same time, people are encouraged to invest in the passive one regardless of valuations. This is just one example that could create interesting distortions in the marketplace.

Investors have been taught that passive is better than active, yet they applaud the closing of the active fund due to valuation, but likely ignore the fact that the more expensive by valuation passive fund is still open. This shows that collectively, investors are not thinking critically, which could be costly.

As a side note, noone knows whether stock prices won’t just keep on going up or whether they would go down. But for someone with a long-term holding period, they should be just sitting on their equities, and letting the magic of long-term compounding do its heavy lifting.

I understand that it is tough to find good quality companies at attractive valuations today. But so far, someone who has regularly invested every single month over the past eight years should have been able to find at least something of value to invest in. This is despite the fact that everyone has been proclaiming stocks as overvalued for these entire past eight years.