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Our investment strategy: Enduring, yet adaptable

February 20, 2014

The world of investing is constantly evolving, and investors, along with the firms that serve them, may feel pressure to keep up. But there's a big difference between thoughtful adaptation and falling for every investment scheme that pops up in your inbox.

Maria BrunoSo how does a global investment firm like Vanguard distinguish between a sound investment idea that could help our clients build wealth over time and the latest investment craze?

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The answer is simple, according to Maria Bruno, a senior investment analyst in Vanguard's Investment Strategy Group. "We don't make decisions based on short-term trends or market noise," she said. "Before we consider adopting any new investment idea, we conduct our own research and make an informed decision based on our findings."

Built on a solid foundation

Since our inception in 1975, Vanguard's investment philosophy has remained the same: Create clear, appropriate investment goals; develop a suitable asset allocation using broadly diversified funds; minimize cost; and maintain perspective and long-term discipline. We believe that adhering to these four enduring principles will help give our clients the best chance for investing success.

While our principles have remained the same, the way we put them into practice has evolved. The changes are never adopted without a lot of thought, research, and planning—and they're typically made in response to fundamental changes in the global financial markets.

Catherine Gordon"We take our time and try to distinguish between what's 'of the moment' versus what's enduring," said Catherine Gordon, a principal in the Investment Strategy Group. "Think of investments like Hollywood actors. There are some actors that become huge household names overnight, only to fizzle out just as quickly. And then there are others, like Tom Hanks or Meryl Streep, who have long, enduring careers. If you were casting a film, who would you rather hire?"

Of course, it isn't always immediately obvious in the entertainment industry who's going to be a flash in the pan and who will become a screen legend. The same is true with investing.

When considering a new idea, Vanguard's investment teams and senior management—the decision-making groups behind any changes to our investment lineup—ask the following questions: Is it enduring? Does it meet clients' needs? Can we offer it at a low cost?

"If the answer to any of these questions is 'no,' it means it isn't a good fit for Vanguard," said Ms. Gordon.

Good things are worth the wait

In 2013, Vanguard introduced two international bond funds. This marked the first time our firm would offer U.S. clients exposure to fixed income markets outside the United States.

While international bonds may be new for Vanguard's U.S. investors, they're certainly not new. In fact, foreign bonds are the world's largest asset class, making up about a third of the global financial markets. So it's not surprising that the introduction of our international bond funds left some wondering, "Why now?" But the decision wasn't a sudden one at all.

"The change was years in the works," said Ms. Bruno. "Vanguard recognized that international bonds could play a valuable role in a portfolio. The main challenges we faced were dealing with the operational risks and transaction costs." As with any other fund launch, we waited until we reached a point of comfort in managing the risks and costs.

In the case of international fixed income, markets have become more liquid and transaction costs and hedging costs have come down. "This made it possible for us to offer international bond index funds to our shareholders at a lower cost," said Ms. Bruno. "So it was worth it to wait and do things the right way, rather than rush into it."

Change isn't always for the best

At Vanguard, we say "no" to new ideas more than we say "yes." And saying "no" when something doesn't fit with our investment philosophy has proven to benefit Vanguard shareholders.

Maybe you've heard of structured investment vehicles, or SIVs? If so, you may recall that they were the hot investment of the mid-2000s.

"There was a lot of pressure to buy and they looked good on paper, with higher yields and AAA ratings," said Ms. Gordon. "But something was off. It just didn't pass the sniff test with our Fixed Income Group."

As the investment world would soon find out, SIVs were huge purchasers of subprime mortgage-backed securities—a major factor in the 2008 financial crisis. While other firms lost millions, Vanguard breathed a sigh of relief. This is another example of how our fund's cost advantage relative to most competitors worked in our favor, and our fixed income team didn't have to reach for yield in order to remain competitive.

"Before the crisis, many thought we'd missed the boat on a great opportunity," said Ms. Gordon. "But in the end, it was good news that Vanguard didn't buckle. And that's an understatement."

Another good example: In the late 1990s, internet stocks were on fire and "dot-com" funds were all the rage. Vanguard wasn't convinced that these companies had staying power, since most of them hadn't been around very long. But after receiving countless requests from shareholders for a dot-com fund, we considered it. The upshot: It wasn't for us.

"Many clients were upset with our decision," said Ms. Gordon. "But then the tech bubble burst in 2000 and dot.com investors lost millions. In the end, saying no was definitely the right decision for Vanguard and for our clients."

While it's important for Vanguard to be able to adapt to changes in our industry, it's equally important to question those changes. Investors should be especially wary when hearing "This time, it's different."

As Ms. Gordon said: "When something is obviously just a fad, we have no problem saying no and moving on."


Notes:

  • All investing is subject to risk, including the possible loss of the money you invest.
  • Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
  • Investments in bonds and stocks issued by non-U.S. companies are subject to risks including country/regional risk, which is the chance that political upheaval, financial troubles, or natural disasters will adversely affect the value of securities issued by companies in foreign countries or regions and currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates.
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