Step Away From Passive Bond Funds?
The two other recommendations made in the article are also worth discussing. The first is that “a secular bear market for bonds is upon us and passive funds like Vanguard Long-Term Bond Index Fund Investor Shares (VBLTX) are not the best ideas to hold now.”
My first comment is that the evidence suggests there really aren’t any good interest rate forecasters, or at least any forecasters more likely to be correct than the collective wisdom of the market (which is embedded in current yields). In fact, the S&P Dow Jones Indices year-end 2015 active versus passive scorecard (SPIVA) showed that over the prior 10-year period, 96% of actively managed long-term government bond funds had underperformed their index. So much for the ability of active managers to outsmart the market by guessing at interest rates.
I would add that we heard the same warnings last year, and short-term Treasurys went on to underperform both intermediate- and long-term Treasurys in 2016. It’s also important to note that today’s yield curve is positively sloped, telling us that the market expects rates to rise. Thus, the only way one can benefit from staying short is if rates rise more than already expected.
Embrace Riskier Stocks?
The third recommendation was that “the mature phase of a business cycle is a good time to steer clear of the riskier stocks in the market, and this makes Vanguard Explorer Fund Investor Class (VEXPX) among the group of Vanguard funds to avoid now.”
As I mentioned earlier, the overwhelming evidence demonstrates that very few actively managed funds have been able to outperform by shifting allocations, or tactically allocating, as suggested. In fact, the evidence on tactically allocating funds isn’t a pretty picture.
For example, Morningstar once examined the returns of 163 tactical asset allocation (TAA) funds covering the period ending July 2010. It’s important to note that, by the close of the period, 39 of the funds no longer existed (because of merger or liquidation). Of the surviving tactical strategies, the median life span was 37 months as of July 31, 2010. That study found that TAA funds generally failed to deliver better risk-adjusted returns, or downside protection, than a traditional balanced index portfolio split 60/40 between stocks and bonds, respectively.
For example, 64 of the 92 (70%) TAA funds that at the time were at least a year old had worse since-inception performance than the passively managed Vanguard Balanced Index Fund (VBINX), with the average underperformance being 2.6 percentage points per year.
Morningstar later updated the study through the end of 2011. They compared the returns of TAA funds to VBINX, which passively invests its assets in a 60/40 stock/bond mix. Following is a summary of their conclusions: