Siegel: Worry Not, Rates Won't Rise Much

Yes, interest rates will go up, but not by much, says the Wharton School professor.

Editor, Europe
Reviewed by: Rachael Revesz
Edited by: Rachael Revesz

LONDON Jeremy Siegel is known as one of the legends of the indexing world. The Wharton School professor, author and senior strategy advisor at WisdomTree Investments was one of the first to develop the concept of the smart beta, or a fundamentally weighted index, which tilts towards dividend-paying stocks rather than following the old market cap strategy.


Siegel spoke to about the great benefits of ETFs, the fact that too many people are chasing active returns, and that investors should not be worried about interest rate rises as they are not likely to go up by much.


Register for our upcoming annual conference in Amsterdam to hear Siegel give a keynote speech on the outlook for global equities and interest rates. What are your views on the proliferation of currency hedged ETFs? Do they add value to advisers?

Siegel: Yes. I think currency hedging definitely has a place in portfolio construction. For dollar-based investors, when they go outside the dollar zone in equities, they take on two risks – equity fluctuations and currency fluctuations. And with interest rates low in the developed world in particular, near zero, there is no cost in hedging those currency risks. As a result I think, looking forward, investors will receive a superior risk-return trade-off by hedging currency risk, particular in developed countries. In 20 years, will investors still invest in market cap indexes?

Siegel: I think we will see a continual migration away from market cap weighting to a more fundamental weighting, based on such fundamentals as earnings and dividends. I think it makes sense. The market often misprices individual stocks by moving more than the fundamentals justify. [By] indexing relative to fundamentals, you’re able to lighten your exposure to those stocks that have moved well above their fundamentals and increase your weighting of stocks that move below what the fundamentals justify. Those investors will receive superior risk-returns on their portfolio in the long run. If everybody piles into these dividend strategies, does the dividend premium disappear?

Siegel: Well, those people who have advocated value stocks for many years have faced this very question: if everybody knows value stocks are undervalued and goes into them, they won’t be undervalued any longer. And of course, if everyone moved into them that would be true. But as Warren Buffett says, the brain is hardwired to go for growth stocks, stocks with rapidly increasing earnings, and as a result in the long term those stocks would be overpriced. So he doesn’t believe there could be a fundamental shift in psychology that would in the long run bring value stocks to the correct level and so we will be able to enjoy those superior returns [of value stocks] for many years to come. And as bonds go back to yielding normal levels, will demand for dividend weightings go down?

Siegel: People have been avoiding dividend and value stocks because they don’t want to be invested in them in a rising interest rate environment. Portfolio managers have been defensive about putting investors in these dividend paying stocks. I think interest rates will rise but not by very much so these stocks will be seen as far superior to fixed income investments, and at that point I think you will see an outperformance by those stocks. You wrote a book in 1994 called “Stocks For The Long Run: The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies” – how does that theory fit in with the commonly held belief that ETFs are short term or inherently tactical investments?

Siegel: Certainly there is an opportunity for short-term trading in ETFs and I’m certain that there are some traders and speculators that use them for that purpose. But many advisers I speak to like them because of their flexibility, because many of these mutual funds limit the number of purchase and sales they can make.


Flexibility doesn’t mean you’re a short-term speculator, it means you can implement your decision at any time rather than investing in a mutual fund that objects to you moving in and out. That freedom is an extremely important aspect of ETFs; much more important than the fact they are used by some people for short-term trading. Do you have any views on the recent headlines about Vanguard founder Jack Bogle’s strong anti-ETF views?

Siegel: He’s had those views for many years, it’s not recent! He does worry about short-term trading, he’s always been worried for that. He was very opposed to ETFs but Vanguard has moved into that direction and has a now very successful range of ETFs.


And by the way it’s not just a matter of flexibility – we know that many of the standard mutual fund fees are far greater than the extra return they make or promise to generate for investors and the performance of these mutual funds has not been very enviable over recent years. ETFs, although there are a few discretionary ones, are almost very well defined as to the index they use and many of them have much lower fees than standard mutual funds and that has also contributed to their popularity. You said in a recent interview that diversification by industry seems more natural than by country. Do you still hold that view?

Siegel: I think you should be looking at both. My statements about diversification about industry is that I believe as years go on the location of the headquarters of a company mean less and less. It doesn’t make much sense to me to diversify by country and to call a firm a French firm when it may be [generating most of its revenue] in America. My belief is you should look at the industry it is in, and the demographics of its demand and where it is produced. I think diversification is dictated far too much by location of origin. Active managers often say: “There wouldn’t be any market without us.” Is that true?

Siegel: There’s always been the case that if 100 percent of people go into indexing, then the individual price of stocks would be undetermined and there would be huge profits then to active managers by selecting firms.


So there is clearly a balance but I believe that there are far too many people chasing the active returns and that’s one of the reasons why, after fees, they have disappointed.


Rachael Revesz joined in August 2013 as staff writer. Previously an investment reporter at Citywire, she has a background in writing content for retail financial advisors and has covered a wide range of subjects in finance. Revesz studied journalism at PMA Media, which has since merged with the Press Association. She also holds a B.A. in modern languages from Durham University, as well as CF1 and CF2 financial planning certificates from the CII.