I have written a couple times before about the respect I have for the Vanguard Wellington Fund, which was founded during the Great Depression and has rewarded investors with 8-9% annual returns since then while delivering the smooth ride you would expect from a fund that typically owns 30-45% bonds. If you read any of John Bogle's work, you will know that the Vanguard Wellington Fund is his largest personal investment.
Anyway, the fund's management team, which had previously abstained from owning Apple stock, recently added some to the fund and offered this rationale:
"We established a position in Apple (NASDAQ:AAPL) during the period. Until recently, the fund did not own Apple shares because we were worried about increased competition, margin pressures, and the uncertainty of the post-Steve Jobs era. The market consensus caught up to these concerns, which are mostly reflected in the stock's price at this point. After its large price correction, we became more attracted to the stock, in part because of the above-average dividend yield, the potential for growth in the dividend in the near future, and the favorable risk/reward profile at its current valuation. We initiated a modest position as the price of the shares began to drop below what we regarded as the intrinsic value. We would not be inclined to make Apple a large position in the fund unless there was either greater clarity on prospects for its future product launches or further decreases in the stock price."
That comment is beautiful. I don't own mutual funds (because I don't understand the logic of paying management teams 0.5-1.5% to pick the same stocks I'd pick anyway) nor do I have much of an opinion on Apple stock, but this paragraph provides a great illustration of the general philosophy that has made The Vanguard Wellington Fund such an enduring holding over the years, and demonstrates why I'd own this fund if I planned on giving money to someone with limited knowledge or little interest in investing.
First of all, the management team explains that they avoided Apple stock when it was being hyped last year and the price was flying above $700 per share. Now that the company trades at 10-11x earnings, the price of the stock has calmed down and will likely offer future returns in line with Apple's future earnings per share growth rate with the potential for some modest capital appreciation due to a potential long-term shift in the P/E ratio towards 13-14x earnings.
Secondly, the company mentioned that they initiated a modest position in Apple stock. That is exactly how conservative investors approach the technology investment. They make investments large enough in size so that if the stock goes up significantly it will bring a material benefit, but simultaneously limits the position's size to the point where an error in judgment will not jolt your wealth-building path too much. That is exactly how you invest in tech stocks intelligently and conservatively.
And thirdly, I loved this line: We would not be inclined to make Apple a large position in the fund unless there was either greater clarity on prospects for its future product launches or further decreases in the stock price. What Van Gogh's Starry Night is to art, that line is to conservative investing. Every intelligent long-term investment takes into consideration the amount of future cash profits your investment will generate, adjusted for the likelihood that you think it will actually happen (i.e. you might think Coca-Cola (NYSE:KO) has a 75% chance of growing earnings by 8% or more over the next five years, while Microsoft (NASDAQ:MSFT) has a 40% chance of growing earnings per 12% over the next five years). As the projected growth rate and/or your certainty about the growth increases, the better the investment becomes. It is so refreshing to see an investment management team explain beforehand that they will become more interested in a particular stock if its price declines.
Even though I don't have a single dollar invested in the Vanguard Wellington Fund, I have great respect for their investing style. They do everything conservative and right. They wait for the hype to die down and go bargain hunting. They recognize the low interest rate environment of bonds, and scale back the duration of bonds in the overall portfolio to reduce the risk when bond rates rise (for those of you unfamiliar with bond investing: long-term bonds get hit much harder than short-term bonds when rates rise). Everything about this fund has a throwback feel to it. It's like one of those guys from the local bank's trust department in the 1940s that bought AT&T stock for widows and orphans is still alive, and you can see it in the sensible strategy and philosophy of each decision made by the Vanguard Wellington management team.