The Vanguard Hot Hands Strategy: Why It Works

One of the reasons that Hot Hands works at Vanguard and not within the greater universe of funds is that Vanguard’s fund objectives and investment policies are very well-defined. With Vanguard’s funds, there’s little room for managers to change their tactics. The managers do what they do, and they keep doing it, no matter how the markets change around them. If they don’t, then generally Vanguard fires them. One thing Vanguard wants is managers who strictly follow their investment styles and objectives.

So using the prior year’s performance as a guide for selecting Vanguard equity funds is not only useful, but very profitable, because investment styles and markets don’t automatically shift once the calendar turns from December to January. And ignoring hot strategies, or going with the “dogs,” as some investment advisers who use a “contrarian” approach like to suggest, can lead Vanguard investors to market-lagging and even negative returns. Dogs are dogs for a reason. They make great pets, but lousy bets.

Let’s get back to the Hot Hands winners. Here are the ground rules for the strategy as I originally set them out a decade ago, in 1995, when I conducted the first analysis. I’ve continued to follow these rules and have updated my research as new funds have been introduced.

I have looked at the best and worst Vanguard equity funds for each year between 1981 and 2007. The funds I exclude are sector funds such as Energy, Precious Metals & Mining, Health Care, REIT Index and the old Utilities Income (now Dividend Growth, which I do include), as well as the international index funds, Emerging Markets Index, European Index and Pacific Index, since they are what I would consider sector funds. I also exclude balanced funds.

Anyway, that’s the background. Now that I have my universe of funds I can figure out which is the “hot” fund each year, follow it in the next year and compare its return with the market benchmark. When I make those comparisons, I measure rolling three-year, five-year and 10-year returns for the Hot Hands fund against Total Stock Market Index, a proxy for the entire stock market, rather than an average Vanguard fund or average equity fund.

Measuring performance against the stock market, rather than the “average” equity fund puts even greater pressure on the methodology to generate decent returns since the market generally outperforms the “average” money manager. Why make my hurdle that much harder to overcome? Because I’m not interested in average performance — you and I want outstanding performance. And that’s what we get with Hot Hands.

You won’t read about Hot Hands funds in any Vanguard Fund prospectus! You might read about similar strategies at different fund families. With a risk-free trial to The Independent Adviser for Vanguard Investors, you’ll get all the details about my exclusive Hot Hands strategy!

What Dan Wiener Knows About Vanguard Can Make You Rich

He’s been doing it for 17 years. And he’s doing it again this year. But this year, Dan wants you along for the ride.

Dan Wiener has been investigating mutual funds ever since the days when he was a financial journalist. For the last 17 years, he’s focused only on Vanguard.

Dan founded the Fund Family Shareholder Association (FFSA) and edits the association’s private members-only publication, The Independent Adviser for Vanguard Investors.

In his position as Editor, he is a four-time recipient of the Newsletter Publishers Foundation’s Editorial Excellence Award and has been mentioned in Barron’s, Bloomberg Personal and the Wall Street Journal just to name a few publications. Formerly, he was a financial columnist for U.S. News and World Report, and Fortune magazine.

Dan is entirely independent of The Vanguard Group, Inc. His only loyalty is to his readers, investors wise enough to secure their futures with Vanguard.

Dan’s two decades of work has made many a Vanguard investor richer than expected. Much richer! The evidence shows that Dan’s advice makes his readers 94% richer than the average Vanguard investor who invests with Vanguard on his own.

This is not a snapshot of selected “good” years. Dan beats the market, Vanguard and your own profit expectations year-in and year-out.

He achieves this by asking the tough questions at Vanguard — and publishing very, very hard-to-find information in his advisory, The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of recent developments at Vanguard.

He doesn’t want you to miss out a moment longer.

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The Independent Adviser for Vanguard Investors provides independent investment advice on the Vanguard family of mutual funds.

Editor Dan Wiener, a long-time advocate of consumer investors, is dedicated to assisting Vanguard shareholders in achieving higher returns, less risk and more confidence in meeting their personal financial objectives.

The service gives members strictly independent and unbiased in-depth information on all of Vanguard’s stock and bond fund offerings, as well as their international funds, variable annuities and money markets.

Included in your service is a monthly newsletter with specific “buy,” “hold” and “sell” recommendations and performance returns for each of Vanguard’s funds.

The service also offers four different model portfolio plans (for conservative, moderate and aggressive investors) using only the finest Vanguard funds.

Dan also keeps you up-to-date on all Vanguard news events and changes in fund management. You will have access to fund manager interviews, fund distribution information, market updates, tax efficiency advice and many other tools to make you’re investing easier and more profitable.

All membership subscriptions entitle members to automatic enrollment in the Fund Family Shareholder Association at no additional charge. Members will also receive access to FFSA’s 24-hour Independent Adviser hotline.

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