Stay Connected! News Daily News Weekly
Sign up to's newsletters.
U.S. Edition
Search Ticker
Bogle: Tilt To Corporates For More Yield

Bogle: Tilt To Corporates For More Yield

Related ETFs: PRF | VTI

John Bogle, Vanguard’s founder who built a second career as an author and the conscience of American capitalism, is still vigorous and relevant at the age of 84. As always, Bogle counsels investors to keep their focus on the long term, and to try to look past the near-term distractions in markets.

Total returns will always be the sum of earnings growth and dividend yield, plus whatever yield the bond market is serving up. Regarding the paltry bond yields that still prevail since markets crashed five years ago, Bogle reckons investors would be wise to work around the overweight in government debt that now characterizes the Total Bond Market Index.

He stressed that even ardent indexers like himself should always be focused on improving indexes, and he does that in the bond market by taking on a bit of extra risk and yields by including corporate debt in his retirement account and tax-free municipal debt in his nonretirement account. So what now Mr. Bogle, after Vanguard and after all the books you’ve written?

John Bogle: I'm going to do everything I can to get a federal standard of fiduciary duty enacted. It’s not going to be easy and it probably won't happen in my lifetime. Also, I’m going to continue being a missionary for indexing until the day I die. But by indexing, I mean all-market indexing and no trading. And by indexing, you also mean market-cap weighted indexes, as opposed to some of these other methodologies, like from Rob Arnott?

Bogle: Yes. Those indexes haven't proved anything in six or seven years. The Arnott fund [the PowerShares FTSE RAFI US 1000 Portfolio (PRF | A-87)] has done a little bit better, maybe 50 basis points better than the total Total Stock Market Fund [Vanguard Total Stock Market ETF (VTI | A-100)]. But it’s 15 to 20 percent more volatile, so you would kind of expect that.

In other words, those types of funds are in the process of proving what we all know to be true over the long run, and that is, if you're willing to take more risk, you may generate some extra return. Although I don’t run this firm, let me say this: Should we be jumping on that bandwagon? I for one hope not. Those things are going to come and go. Five years into a relatively strong bull market and notwithstanding the continuing macroeconomic uncertainty after the crash, what's an investor to do? How do you protect returns that are in the bag and enhance future returns at this juncture?

Bogle: Well, I think that is a weapon that should be used sparingly. You're taking a gamble when you get out. You're going to be much more apt to get out at a time when the markets are a little depressed and get in when the markets are high. That's the pattern of optimism and pessimism and hope and fear and greed that has characterized the markets forever.

People aren’t going to know how to do that—it’s market timing. I’d say, never be out of the stock market. It just makes no sense to me whatsoever. But maybe you can trim taking 15 percentage points off the table or something like that. You mean 15 percentage points of straight equity exposure, for example?

Bogle: Yes. If you were going to go in that direction, pulling 15 percent out of your equity-type risk allocation, do you play defense in T-bills or do you go more into a total bond market product like the Vanguard Total Bond Market ETF (BND | A-96)? What do you do?

Bogle: Well, I go to basically short-term and intermediate-term municipals in my personal account, and, in my retirement plan account, which is my largest asset here, I use intermediate-term corporate and short-term corporate debt.

The bond index is much more heavily weighted in government debt—72 percent—than most investors need to be. These days, when you need yield so badly, I don't think you should sacrifice all that yield. The spreads are large between governments and corporates, 100, 150 basis points or more. People are dying for income, and I'd rather have a lower Treasury position, change the Bond Market Index a bit, have a lower Treasury position and get extra income the way I’ve described instead of jumping into high-yield bonds. So, are you saying essentially that this is a way to think about the bond market right now given the shortcomings with the Total Bond Market Index?

Bogle: Yes. I think the index is wrong. I'm the consummate indexer. I started that first stock fund, the index fund, and started the first bond index fund, too. But I think we should constantly be examining the validity of the indexes we're looking at and not say, “Well, that's the history and we're going to accept it there,” particularly in this yield area.

Remember that there's a little credit risk in bond portfolio, but not very much, and no credit risk in a government bond portfolio. And your return is going to be determined by the income, basically the coupon you get. That's 100 percent of the bond return in the long run. That doesn't mean it’s going to have to be perfect for the next two or three years, but in the long run, it’s a very good rule of thumb, and I think the correlation is 0.91 or 0.92.

By the way, the exact same thing is true about the stock market: In the short run, it’s driven by these emotions—higher and lower PEs—but in the long run, it’s driven by dividend yields plus earnings growth. This is the formula I've been using for decades now. And when you add the dividend yield plus the earnings growth, what does it look like, compared with the historical pattern?

Bogle: If we're lucky, we could get 5 percent earnings growth and the dividend yield is about 2 percent—that should give you a 7 percent fundamental return. If P/Es go down a little bit, significantly even, that might take it to 6. And if P/Es were to rise, which I think is less likely, it could add a point or two, take that 7 to 8 or 9.

The long-term market return we've been reading about since the beginning of time, 9 percent, was for most of the period 4.5 percent dividend yield, 4.5 percent earnings growth. But we know the dividend yield isn't 4.5 percent anymore. So that's why I don’t look to the 9 percent to return. How far back are you going historically when you talk about the 4.5 percent yield?

Bogle: About 100 years, and then for 30 years now, really, 2 percent has kind of been the number. And you have to think about that: The bond market fund probably yields about 1.9 percent today, and it makes a 2 percent yield on stocks seem pretty good. So that 1.9 percent on the total bond market fund, is that about how you would regard the fixed-income return that's there for the taking now, or is there a better way to look at it?

Bogle: I'd give it a corporate bias, and you can probably get up to 2.75 percent. And that relates to this tilt you spoke about earlier with regard to the intermediate and short term as you would tilt away from the total bond market?

Bogle: Yes. Let’s look at total return in a combined stock and bond portfolio: Going back to your stock market tally of earnings growth and dividends, plus the bond market with the tilt you talked about with the corporate side, what do you come up with?

Bogle: It’s about 7 percent for stocks and about 2.75 or 3 for bonds if you're willing to take that extra risk. So you add them up and divide by, say, 2. In other words, if you've got half of your portfolio at 7, and half of your portfolio at, say, 3, that's 10. And after you divide by 2, that's a 5 percent return. Are you optimistic about the market in general? And are you optimistic about American capitalism on the whole, even considering all the difficulties in Washington, D.C., in the past few years?

Bogle: Well, I'm not really happy with it, but we've been through a lot of these things in the past, and usually reason prevails. I think we're at a time in our society where I'm less confident about reason prevailing. The right wing and the left wing have basically compromised our ability to govern ourselves, and that's a pretty important thing. And Congress is at loggerheads and will be for a while. So we just have to hope we will, for want of a better word, muddle through. What did you make of Warren Buffet in his investment note recently, going on the record saying, with regard to his wife’s trust, that he favored the Vanguard 500 Fund plus 10 percent allocated to some short-dated government fund that's really a cash proxy? He's the most legendary active investor over the last half century, and here he is making the case for an index fund, or nearly at the end of the line, making a very modest argument that apparently is quite powerful. What's your response?

Bogle: Well, No. 1, he’s been a booster of index funds for as long as I can remember going back to a great blurb he did for my book “Bogle on Mutual Funds.” He’s been a booster and that's 20 years now. And he said when the dumb investor—this is almost an exact quote—realizes how dumb he is and buys an S&P 500 index fund, he then becomes smarter than the smartest investor.

So I thought it was wonderful when I read it. Someone said I'm now index funds’ second-best salesman. And I felt like calling the guys in our order room over here and saying, “Get out the peach basket, in comes the money.” I don't know if that's happened or not. But it’s not as if I'm not happy with an endorsement by Warren Buffet—anybody would be, and I surely am happy with it, delighted with it, and particularly when he gets down to cases where we're talking about his own money.

But the miracle of indexing is the simplest miracle ever created. Think about it this way: There's a stock market out there that we all own together and it’s worth, say, $17 trillion today. So we draw that big circle. About 30 percent of it is owned by people who have figured it all out and they own the total stock market by owning everything in it and never trading. And those are the indexers. And index funds are about, I think, 33 percent of the market today, counting institutional and mutual fund investors.

The other 67 percent of the investors are also indexers themselves as a group. They own the same stocks as the direct index investors. They just trade them back and forth with one another. So it is a mathematical impossibility that they will outperform those who go to indexing directly and buy a low-cost index fund. That is a truism that many people just don’t quite grasp, isn’t it?

Bogle: It's just the mathematics, and it’s been proven over and over again.




Post a Comment
Home page: (optional)
CAPTCHA Image Reload Different Image
Type in the
Email follow-up comments to my e-mail address SUBMIT