'Random Walk' Malkiel on rates, risk, and why Vanguard changed
Princeton prof tells why fund giant won't disclose CEO pay
Princeton finance professor emeritus Burton G. Malikel is at it again: Publisher W.W. Norton has put out a 12th edition of his 1973 best seller, A Random Walk Down Wall Street, one of the books that gave intellectual support to Vanguard Group founder John C. Bogle's successful effort to boost index funds as the cheapest, surest way for most investors to profit over time from the stock and bond markets. Malkiel served on Bogle's board and stayed on until 2005 when he approached its age limit.
Malkiel still argues, like Penn's Jeremy Siegel (the self-proclaimed Wizard of Wharton), that investment markets tend to regress to a median longterm performance, so stock-pickers who do well for a season, or even a decade, are basically lucky, and probably costing you fees that drag down your long-term profits. We asked him what's new in this era of digital ubiquity, low interest rates and uneven growth -- and for some insights on Vanguard, since he's been off the board a few years. Here's a transcript, edited for clarity:
Stocks, with dividends: What do you do when you're retired, you're living on income (from investments), and you're as much of an indexer as I am? The problem with (Vanguard) Total Bond Market Fund is that it's about two-thirds either government securities or government-guaranteed securities, with a yield of 2%. Which is just about where the Federal Reserve inflation target is. It's pretty hard to live on 2 percent a year, even when inflation is below that.
So I have suggested a couple of things. One is to (replace) at least a part of what would have been a regular bond portfolio, with a dividend substitution portfolio of buying relatively safe stocks -- I'm not talking about speculation -- I'm talking about stocks that have had generous and indeed growing dividends.
The example I've used is AT&T. Buy their bonds, the yield is a little less than 2.5 percent. (By contrast,) AT&T stock yields about 5 percent. And that dividend has been raised every year that AT&T has existed.
Are stocks riskier than bonds? Absolutely. But I can't believe that an investor won't be better off with a substitution... I've mentioned funds including Vanguard funds that have been dividend or dividend growth funds investors could use.
Muni bonds: The second part of the strategy is to maybe tilt a little away from indexing and look for parts of the bond market that do give generous rates of return.
Are stocks riskier than bonds? Absolutely. But I can't believe that an investor won't be better off with a substitution... I've mentioned funds including Vanguard funds that have been dividend or dividend growth funds investors could use.
Muni bonds: The second part of the strategy is to maybe tilt a little away from indexing and look for parts of the bond market that do give generous rates of return.
With all the publicity that's been given to (bankrupt) Detroit and (low-rated) Puerto Rico, municipals are cheap. Theyre not like the U.S. Government, that can print its own money. But you are absolutely rewarded for owning them. That makes a lot of sense.
Junk bonds and how not to buy them: I'm not suggesting you go crazy on high yield securities. To the extent I hold the corporate high yield, I would go with a Vanguard fund, rather than one of these (closed-end or untraded high-yield funds, like those sold by Franklin Square or Nicholas Schorsch's Cole Capital through brokers) for two reasons:
One, Vanguard is extremely conservative. They are not reaching for yield by taking on very high risks.
One, Vanguard is extremely conservative. They are not reaching for yield by taking on very high risks.
Second, and I've emphasized this for a long time, in a low return environment, the one thing I'm absolutely sure about, the lower the fee I pay to the purveyor of the investor service, the more there will be for me. Of course, the quintessential low fee funds are Vanguard funds.
What about those smart-beta funds, that promise an index-plus-a-few-smart-changes approach? As I write in this edition, passive investing works.
So what happens when we tilt it in particular ways? There are arguments that we can have a 'beta-one' portfolio with a higher rate of return and no riskier. There's a lot of empirical work that suggests you can then show a value effect, a small-firm effect, a momentum effect.
What about those smart-beta funds, that promise an index-plus-a-few-smart-changes approach? As I write in this edition, passive investing works.
So what happens when we tilt it in particular ways? There are arguments that we can have a 'beta-one' portfolio with a higher rate of return and no riskier. There's a lot of empirical work that suggests you can then show a value effect, a small-firm effect, a momentum effect.
But my own view is that the emporer has no clothes. It works a lot less well than its supporters argue. Don't kid yourself that this is brilliant investing. This is taking on a much riskier portfolio.
(Money manager) Rob Arnott has made a huge business with so called 'fundamental indexing.' which he says is this new great invention, a combination of value investing, plus size. Over his history, he has outperformed. In the book, I dig into that and show he really only outperformed in one particular period, coming out of the financial crisis of 2008, when he doubled the weight of his portfolio in banks -- and put 15% of his portfolio in two stocks, Citi and BofA.
(Money manager) Rob Arnott has made a huge business with so called 'fundamental indexing.' which he says is this new great invention, a combination of value investing, plus size. Over his history, he has outperformed. In the book, I dig into that and show he really only outperformed in one particular period, coming out of the financial crisis of 2008, when he doubled the weight of his portfolio in banks -- and put 15% of his portfolio in two stocks, Citi and BofA.
Don't tell me that wasn't risk! A lot of people thougth at the time that the government would let 'em go out of business. (But Arnott was right, and reaped profits when the banks were bailed out and their stocks recovered.) I give him credit. But dont tell me this is brilliant new investing. It's taking on a whole lot of risk.
Junior Princeton scholars and his book updates: I'm an emeritus professor. I generally just give lectures. I'm not teaching a regular course. I had grad research assistants, and yes they helped.
Exchange-traded funds: There has been a lot of good competition in the ETF arena. I mention BlackRock ETFs as well as Vanguard. You don't want a really risky high yield portfolio. You certainly do want one that's low expense.The dangers of going overboard on that part of it are very real
Junior Princeton scholars and his book updates: I'm an emeritus professor. I generally just give lectures. I'm not teaching a regular course. I had grad research assistants, and yes they helped.
Exchange-traded funds: There has been a lot of good competition in the ETF arena. I mention BlackRock ETFs as well as Vanguard. You don't want a really risky high yield portfolio. You certainly do want one that's low expense.The dangers of going overboard on that part of it are very real
Vanguard's decision to go ETF despite retired founder John C. (Jack) Bogle's concern that short-term trading hurts small investors: I have been off the Vanguard board for eight years now, but I've seen like everyone else that ETFs are a part of Vanguard that has grown very, very rapidly. Now Vanguard was slow getting into the ETF business. And now the flows into ETFs are enormous. They have changed the composition of the Vanguard Group. I would have been in favor of doing it earlier than we did.
It was Vanguard's management (not the board) that were reluctant. But they were pretty well decided by the time I stepped down. Management has become somewhat more aggressive.
Jack Bogle in particular was very negative about the product, because the product is advertised that you can get in at 10:30 in the morning and get out at 2 in the afternoon. And Jack would say, 'That's crazy, people are going to cut their throats!' But there's a particular reason Vanguard did this:
Vanguard added ETFs so brokers could earn Vanguard commissions: It became clear, to the board and management, that the way the mutual fund business had operated, was that a lot of funds would basically give kickbacks to brokers who sold them. Vanguard didn't do that. The broker managing your account doesn't get a commission for a Vanguard fund.
He can get his commission for buying you a Vanguard ETF. That was probably very important in terms of the Vanguard evolution into ETFs. It's a much bigger thing (than Bogle's worries about short-term trading.)
From my standpoint it is good for the investor because Vanguard has the cheapest ETFs. Blackrock is fine. But Vanguard is as good as anybody else. And Vanguard has avoided the crazy ETFs that have three times the (volatility) of the S&P 500. Vanguard has put together only the ETFs that make sense.
Vanguard as a giant activist investor, pressuring companies to boost profits: Yeah, it's a good thing. It's particularly important for Vanguard.
Vanguard as a giant activist investor, pressuring companies to boost profits: Yeah, it's a good thing. It's particularly important for Vanguard.
Remember the old saying was, 'Hey, institutional investor, if you dont like what the company is doing, sell the stock and go somewhere else.' But Vanguard can't do that because they have the indexed funds.
So it behooves them to do exactly what (Bogle successor) Bill McNabb said (and urge companies to improve governance and results). It's extremely important. They do it very well and spend a lot of time on it. They do it very thoughtfully and carefuly. That is unquestionably a very good thing.
What does Vanguard pay its own executives? I can't tell you what Bill McNabb gets. I can tell you, certainly, when I was on the board going back to Bogle and (immediate successor John) Brennan, the pay was extremely moderate relative to what corporate America was paid.
So why don't they report it? I think probably what influences them, if your salary is a seven-figure salary -- I'm sure Bill McNabb has a seven figure salary -- I think they feel people won't understand that if Bill McNabb gets $2 million a year, that is peanuts, relative to what a hedge fund guy gets, what most corporate executives get.
So why don't they report it? I think probably what influences them, if your salary is a seven-figure salary -- I'm sure Bill McNabb has a seven figure salary -- I think they feel people won't understand that if Bill McNabb gets $2 million a year, that is peanuts, relative to what a hedge fund guy gets, what most corporate executives get.
But there will be some shareholders that think this is an absolute scandal.
I've been on over two dozen corporate boards. Vanguard was in the lowest decile of pay. So at least on a relative basis they had not gone crazy on pay, at least when I was on the board.
Is the era of celebrity investors over? It's probably less likely that we are going to see Warren Buffetts and Peter Lynches in the future. It's such a competitive business now. It may well be a little less likely that there will be these so-called genius investors.
I've been on over two dozen corporate boards. Vanguard was in the lowest decile of pay. So at least on a relative basis they had not gone crazy on pay, at least when I was on the board.
Is the era of celebrity investors over? It's probably less likely that we are going to see Warren Buffetts and Peter Lynches in the future. It's such a competitive business now. It may well be a little less likely that there will be these so-called genius investors.
I think there will be fewer of them in the future. Even Warren Buffett would say, 'The thing you do now, don't buy (his investment holding company) Berkshire Hathaway, buy an index fund.'