Tuesday, 2 December 2008

Does index investing still make sense in volatile markets?

John Bogle, founder of The Vanguard Group Inc. and the popular Vanguard 500 Index Fund, is 79, and has seen 10 bear markets in more than five decades in the investment business. Today, amid a US economic recession he is more vocal than ever in urging long-term investors to bet on the market as a whole rather than picking individual stocks. It's a low-cost alternative to actively managed funds, and an approach that Bogle championed during more than two decades as Vanguard's chairman and chief executive.

This is what he had to say in an interview with The Associated Press:

Q: How long do you expect the U.S. recession to last?
A: I believe it will take longer than most experts believe to get through this. I'd say it will be a year and half to two years before we turn upward. The international economy is going to go through a similar phase.
Q: Where should we look for clues that the economy is rebounding?
A: In the U.S., the first signs will come when employment starts to tick up again, and when retail sales pick up. That could be as long as the next Christmas season. It's sure not going to happen this Christmas season.
Q: What's that mean for investors, given stocks' historic returns of about 9 percent a year?
A: I believe in owning the entire U.S. stock market, and holding it forever. Or, to put it another way, to own the entire U.S. business sector, and the stock market will ultimately reflect that sector, forever.
I think it's likely - and here I'm just totally guessing - that the stock market anticipated most if not all of the decline we're facing in the economy. It almost always moves before the economy goes up and down.
I think investments you continue to hold through this decline will give you a return better than you can find in other places. And that is a crucial part of this analysis. We know what bond returns will be in the next 10 years - roughly 5 percent for long-term government bonds, or about 4 percent for short- to intermediate-term bonds. So if stocks produce 6 percent, while you endured the volatility, you increased your total return.
Money-market funds are now yielding less than 2 percent - call it about 1.5 percent. That doesn't look anything like 6 to 9 percent for stocks, especially when you compound them over a decade. I would not flee the market now.
Q: So does it make sense for investors to stay mostly in stocks, even with the high volatility?
A: Any investor who looks at probabilities has got to look at their own consequences. For example, if you are so close to the edge in the value of your retirement plan that you can't afford to have stocks go down one more iota, you have to get out of the stock market. I hate to say it, but if the consequences to you are disaster, you can't be there, it's risky. On the other hand, if you're young and have many years to recoup, you can be there and should be there.
Q: What about for someone older, like yourself? You're 79.
A: If you're older and have taken my eternal advice, and think about a rough rule of thumb that your bond position should be roughly equivalent to your age. I should be 79 percent in bonds. It turns out I'm at about 80 percent. I happened to start this in 2000 when the stock market was absurdly high. I was about two-thirds in stocks when I made the changes in my asset allocation. So I switched to about two-thirds bonds. I haven't changed my allocation since then. But with the bond market having a positive total return in the eight years since then, and the stock market having a fairly substantial negative return since then, that's driven my stock position down and my bond position up to 80 percent. It's not some slavish adherence to a rule of thumb.
I feel like anybody naturally would - stupid to not realize it could get this bad, but on the other hand, I think most people would be envious over my return of the last 10 years.
Q: How do you respond to people who say markets have become so volatile that conventional wisdom to buy stocks and hold them long-term no longer makes sense?
A: They're wrong to question it. Because for all of the last century really, stocks have gone up and down with some frequency. In fact, this is my tenth bear market, and two of them, in 1973-4, and then in 2000-2002, markets went down 50 percent - more than the current market decline.
Q: To what extent is the market decline a reflection of decreased earnings?
A: The total value of the U.S. stock market had dropped from about $18 trillion dollars to about $9.5 trillion. So there has been an $8.5 trillion drop in the perceived value of corporate America. I think that's inconceivable. I don't think the value of corporate America has dropped by almost half. I mean, these are companies with capital - they make useful products and services, they're efficient, competitive, innovative. Does anybody really think the value of American business changes by a trillion dollars a day? Well, they may, but I don't.
It may be the market was overvalued at the beginning of the period. It may have been $1 trillion or $2 trillion overvalued when this thing started. But that still leaves $7.5 trillion to account for.
Q: Does your index fund philosophy still hold up in this economy?
A: The index is the ultimate buy-and-hold, all-American business strategy. It is the gold standard; there is no way around it. Mathematically, indexing wins. And if the data don't show indexing wins, well then, the data are wrong.
Quoted from: "2009 Outlook: Vanguard's Bogle sees long recession" by Mark Jewell, Forbes.com, December 1, 2008.

Where have all the money gone?

The mutual fund industry has gotten demolished this year, losing 21% of its assets in just five months, and some believe that exchange traded funds (ETFs) are the reason why.

As of Oct. 31, mutual funds had $9.5 trillion in assets, compared to $12 trillion under management on May 31. October showed record amounts of outflows from stock funds, a whopping $86 billion, and fixed income funds recorded outflows of $44.3 billion.

A combination of redemptions and huge losses of all stock funds has lead to this dramatic decline, states Sam Mamudi of The Wall Street Journal.

So where have these outflows gone? A huge portion has been shifted to ETFs. Over the first nine months of the year, net infows of $104 billion have been seen in the ETF market. ETFs are versatile, taking power and control away from fund managers and putting it the hands of advisors, states Richard Romney of ETF Portfolio Strategies.
Quoted from: "$2.5 Trillion Leaves Mutual Funds - Where Is It?" by Kevin Grewal, ETF Trends, December 01, 2008.