Less Active is More Productive When Vanguard Gets More Passive

The Vanguard Group, the shareholder owned mutual fund complex and one of the nations largest providers of employee retirement plans, recently announced important changes in two of its most widely used strategies — the Asset Allocation Fund and the family of LifeStrategy Funds. These changes are interrelated because Asset Allocation has been one of the building blocks of the LifeStrategy series.

Long a leader in passive strategies (the company manages one of the oldest and largest, its S & P 500 Index Fund), Vanguard has had a pretty good reputation for some of its active funds as well. Its Windsor, Wellington and Wellesley funds have served investors well for decades. These funds are advised by the Wellington Management Group (founded in 1928) — where Vanguard founder John Bogle got his first job in the industry. The Quantitative Equity Group (QEG) oversees all of Vanguards active and indexed products.

It’s worth reviewing the difference between active and passive investing. Passive investing has two basic components: 1) establishing a strategic asset allocation, using fixed weights among asset classes (say stocks and bonds) with periodic rebalancing back to the target weights and 2) using passive (index or index like) vehicles to implement the asset classes. By contrast, active investors vary the weights between asset classes, based on predictions as to which may outperform in the immediate future and also choose among the securities in a particular index, in an attempt to outperform the index.

Asset Allocation Fund (with $8.6 billion in assets) has been managed actively, allowing the manager (Mellon Capital Group, now being replaced by Vanguard’s in house QEG and Fixed Income Group) to invest anywhere from 0% to 100% in stocks, bonds or cash — with widely varying results. The new strategy will require a fixed 60/40 equity/bond portfolio. In addition, Asset Allocation Fund, following shareholder approval, will be merged into the Balanced Index Fund, which has had a fixed allocation all along and which uses only indexed components.

The changes to the LifeStrategy Funds (with $25 billion in assets) are parallel. LifeStrategy consists of four different asset allocation choices, with varying exposures to stocks and bonds, from 20/80 to 80/20. Vanguard had used Asset Allocation Fund (and the actively managed Short-Term Investment Grade Fund) as part of the portfolios. They are being eliminated in favor of using three broad market index portfolios in various proportions as the underlying components: Vanguard Total Stock Market Index Fund, Vanguard Total International Stock Index Fund and Vanguard Total Bond Market II Index Fund. These are the same funds Vanguard uses to populate its Target Retirement Funds.

The changes will both simplify decision making for investors in choosing among these funds as well as remove some of the unpredictability in performance. Expenses will also be lowered to between 0.14% and 0.18%. As is often said, less is more. This seems especially true in fund management, where it strikes us that less active management and lowered expenses offers more reliable investing. Apparently, Vanguard thinks so, too.

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