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Keep it straightforward

19 November 2015 | Portfolio construction

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Leo Schulz: The Vanguard LifeStrategy funds are straightforward. They are made up of index funds. There are no active or tactical strategies. This keeps them low cost, but does it work?

My name is Leo Schulz, senior investment writer at Vanguard Europe. I have with me Todd Schlanger, an investment strategist in Vanguard’s Investment Strategy Group.

Todd – what’s the answer? Why does it work?

Todd Schlanger: Yes, we think it does.

Outwardly simple but inwardly sophisticated.

60/40 fund has 25 sub-asset classes, including emerging market and small cap. Each holding weighted by a market consensus determined by aggregation of every investor.

Leo Schulz: But the funds consist entirely of bonds and equities. In this modern world, where news travels fast, where markets are highly correlated, is that enough?

Todd Schlanger: Bonds and equities have low correlations and therefore provide excellent diversification.

Liquid, low-cost, transparent, public markets.

When we look at alternative asset classes, those benefits reduce.

Commercial property. Attractive due to its yield, 4—5%. But it’s an illiquid asset. Buildings can be very difficult to buy and sell. There is no public market, like a stock exchange, so there are no live prices.

Property is not equivalent to a bond. If you look at the global financial crisis, equity fell 32%, property fell 27% and high-grade bonds rose 7%.

REITs offer simple, liquid access to property and make up 5% of the UK equity market + about 2% of the global market… . So if you do buy a property fund, you are to some extent replicating something that we already have in LifeStrategy.

Leo Schulz: What about commodities, another alternative asset class many investors find attractive?

Todd Schlanger: Many of the same problems you have with property. You can’t buy commodities directly, so access is through futures. Futures are liquid, but they have no cashflows, so the value of a future is set through supply and demand.

Our research also shows that as more investors have come into commodity futures, such as hedge funds, the more they correlate with other types of financial asset.

Leo Schulz: About how much would you need to invest, say in property or commodities, to make a difference?

Todd Schlanger: Our research shows that you need an allocation of 10% to make any real difference to a diversified portfolio. If you are going to invest in specialist funds, you need to be prepared to commit to it. You also need to think about what you’re going to take out.

Leo Schulz: So, in your view, a straightforward approach does work?

Todd Schlanger: Absolutely.

The funds offer a diversified portfolio that will suit a broad range of clients. The focus is on low cost, high quality, liquid investments. Simple on the outside, sophisticated on the inside.

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