currency/speculative play; but you really think about it from a building block of a ... taxable funds are actually lower
Striking a balance: Keys to building a diversified portfolio Dividend-paying stocks: A viable fixed income replacement?
Meet the speakers
Amy Chain: “In view of the low yields being paid by bonds, what do you think of using dividend-paying stocks to replace a portion of your fixed income allocation?” Fran, can I ask you to take this question? Fran Kinniry: It’s actually the question we take most often from our investors. The lowyield environment that has existed now since 2008 has really been a penalty, if you will. to those who have been conservative or moderate as an investor. Investors have long been able to have a let’s call it “normal” return for being conservative. But over the last five to six years, we’ve seen money markets hovering around zero and bonds hovering around one to three percent; and that’s concerning because, in the world of, “I need more. I want more,” which is very understandable—that’s a pretty low return. We’re seeing investors even take on more equity risk, go to dividend-paying stocks. We’re hearing all the time dividend-paying stocks are yielding more than treasury bonds.
Amy Chain Moderator
But we’ve done some research on this, and what you see is dividend-performing stocks perform like stocks in the bear market. And what we mean by that is we have funds that we can look at and identify, even at Vanguard, that have higher dividend yields. And in 2008 and 2009, they actually went lower than the S&P 500 and lower than the total stock market. So dividend-paying stocks, the most important thing you have to understand is they are not bonds; and they should not be substituted for bonds. If you want to have an overweight to dividend-paying stocks in your equity portfolio, I would do that with some caution, especially if we’re talking to a taxable audience. Dividends are not really a tax-favored way to invest, so you are leaving some money on the table from taxes. But, certainly, we would not think that dividend-paying stocks are a substitute for bonds, which will hold up or have held up well when equities are under some of their bad environments.
Investing abroad: Currency hedging in international bonds Amy Chain: Do you need international bonds in order to have a truly diversified portfolio? Fran Kinniry: Yeah, I think the first thing you have to think about with international bonds is, is the bond portfolio hedged back to the U.S. dollar or not? And that’s a big difference. The vast majority of bond funds that are out and about today in the investment landscape products are unhedged, meaning that you have not only the bond component but the currency component, the currency fluctuation. And what we see from that is the currency fluctuation is significantly larger than the bond component, and so it actually is a higher volatile asset class. And, really, the role of bonds in a portfolio is really to be a diversifier, (continued on next page)
Fran Kinniry Vanguard Investment Strategy Group
to maybe be a more conservative asset class. And so for the products that are out in the marketplace that are unhedged back to the dollar, it is a much more volatile return stream; and it has not really done the greatest job diversifying equity risk. Amy Chain: So rule number one, look for a hedged fund—not a hedge fund, a hedged portfolio. Fran Kinniry: Right, so rule number one is, first, go underneath the covers to your fund and figure out is this fund hedged back to the U.S. dollar or not? There’s nothing wrong if it’s not, but I would put that in your high-risk bucket, right? So if you really are buying it as a diversifier now, not as a high-risk/high-potential return, really, the unhedged is more of a currency/speculative play; but you really think about it from a building block of a portfolio. We really believe that a hedged bond portfolio—so hedged back to the U.S. dollar, non-U.S. investments—is a good diversifier. Amy Chain: What portion of the portfolio do you believe should best be invested outside of the U.S.? Fran Kinniry: We don’t really say that there’s an exact answer. We do believe that most of the benefit occurs as you go from none to some. So as you go from 100% U.S. to 10% nonU.S., 20% non-U.S., you’re picking up a lot of the benefits. If we were pinned down to one number, we would probably say 30% is the optimal number. Amy Chain: And that’s 30% of your equity allocation within your overall portfolio? Fran Kinniry: Exactly. So let’s say if you have 60% stocks, 40% bonds, of that 60, 30% of that would be 18. So you would have 18% non-U.S. But, again, that’s not an exact science. If you have 25 or you have 35 or you have 40, all of those would be reasonable, acceptable answers. But if we are pinned down to a number and in some of the asset allocation models, we have to have one number, our lead portfolio advice or recommendation, for lack of better words, is 30% as the starting point.
Can active and passive strategies coexist in one portfolio? Amy Chain: Let’s answer a question in how to think about using a passive investment strategy versus an active investment strategy. Fran Kinniry: Vanguard really believes that active and index are complementary. We fully believe in both. A lot of people may know Vanguard mostly as an index provider, but what we really, really believe in is low cost. And so we have a very, very strong track record of professionally managed—with world-class managers—at low cost. So if you’re going to do active anywhere, we have the ingredients for success on how to do active management. It’s really around talent—you know, the people, the philosophy, the talent, and then giving them low cost to make that work very successfully. Most of our bond funds that the audience may be investing in today are tax-exempt bond funds, which are world class, are all actively managed. But what they give investors is a great investment team with great people, and the costs of our actively managed tax-exempt and taxable funds are actually lower in cost than most of the ETFs and indexing out there. So I really wouldn’t get hung up on active index as much as I would what are the details of the investment you’re considering. Right, is it low-cost or high-cost? Do you know the people well? Do you believe in the process and the people? Those would be the things I would look at rather than the label active/passive.
For more information about Vanguard funds, visit advisors.vanguard.com, or call us at 800-997-2798 to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing. All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.
Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
Vanguard Financial Advisor Services™
Vanguard ETF Shares are not redeemable with the issuing Fund other than in Creation Unit aggregations. Instead, investors must buy or sell Vanguard ETF Shares in the secondary market with the assistance of a stockbroker. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
P.O. Box 2900 Valley Forge, PA 19482-2900
Investments in stocks issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.
© 2014 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.
Investments in bonds are subject to interest rate, credit, and inflation risk.
BLDPTR 102014
