March11 Vanguard Presentation
March11 Vanguard Presentation
March11 Vanguard Presentation
March 9, 2011
Walter H. Lenhard, CFA Senior Investment Strategist Vanguard Quantitative Equity Group
Indexing philosophy
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Indexing philosophy
The success of index investing does not depend on market efficiency Beating the market is extremely difficult Costs matter By consistently earning the return of the broad market, you have the potential to outperform most investors
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The zero sum game means that after cost, a majority of dollars will underperform the costless market benchmark
The holdings of all investors aggregate to form a market Outperformance by one, necessarily means underperformance by another The key to increasing the likelihood of remaining on the winning side is by lowering costs (but maintaining skill)
Tax impact
Source: Vanguard.
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183 165
135 111
71 43 10
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48 38
26
3 10
-5 to -6 -4 to -5 -3 to -4 -2 to -3 -1 to -2 0 to -1 0 to 1 1 to 2 2 to 3 3 to 4 4 to 5 >5
Sources: Lipper Analytical Services, Wilshire Associates, and Vanguard. Past performance is not a guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index. As of December 31, 2010.
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110 104
S&P 500
79
47 41
3 <-6
1 -5 to -6
2 -4 to -5
13 -3 to -4 -2 to -3 -1 to -2 0 to -1 0 to 1 1 to 2
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5 >3
2 to 3
Sources: Lipper Analytical Services, S&P, and Vanguard. As of December 31, 2010.
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85% 78% 71% 65% 67% 65% 61% 51% 54% 73%
Sources: Lipper Analytical Services, S&P, and Vanguard. Number of funds for each time period: 1year, 2,391; 5year, 1,767; 10year, 1,044; 20year, 173. As of ended December 31, 2010.
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50
47 40
40 35 30 25 20 12 10 35 28 25 33 34
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0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
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14.0
12.0 10.5 10.0 8.9 8.2 8.0 6.5 6.0 4.0 4.0 5.1 9.7 9.0 10.9
2.0
0.0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
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Reconciliation
Index updates
Execute trades
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Three levels of risk control: Goal is to minimize risk to avoid unintended bets
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Te ch no l
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En
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Fi n
In d
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Large-Cap Equity
Portfolio Characteristics
Weighted Median Market Cap Dividend Yield Price/Earnings Ratio (1-year forward) Price/Book Ratio Estimated 35 Years EPS Growth Rate Return on Equity Long-Term Debt/Capital Number of Securities
Te l
ec
3
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Portfolio level
om
tili tie
na r
1 2
Sector Weights
Factor level
Sector weights Market capitalization Volatility Style
og y
ia ls
er g
ca r
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Index methodology
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Sources: MSCI, Russell, and S&P. MSCI, Russell, and S&P market-capitalization ranges calculated by FactSet as of December 301,2 009.
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+ More Style Purity - High Turnover - Higher Cost - Less Tax Efficient
- Less Style Purity + Lower Turnover + Lower Cost + More Tax Efficient
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Buffer zones
Source: MSCI.
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Sector weight
Market Index
11.0% 9.9 10.4 16.4 11.6 11.4 18.8 3.9 2.8 3.8 100.0
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Performance Convergence
Large-Cap Indexes
S&P 500 2.24%
Growth Indexes
S&P 500 Growth Russell 1000 Growth MSCI US Large Cap 300 Growth 3.44%
Value Indexes
S&P 500 Value 0.92%
Russell 1000
2.51%
3.91%
0.96%
2.49%
3.81%
1.05%
Past performance is no guarantee of future results. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
Source: Vanguard
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Fair-value pricing
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Nestle
Nestle
$55
11:30 a.m. ET European markets close
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$53
4:00 p.m. ET U.S. markets close
$50
$55
$45 FVP
$40 FVP
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The difficulty of active management The role of indexing in a client portfolio Combining active and passive strategies
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Data: 8,775 hiring decisions by 3,417 plan sponsors delegating $627 billion in assets. 869 firing decisions by 482 plan sponsors withdrawing $105 billion in assets. Analysis covers the period 1996 through 2003.
Source: The Selection and Termination of Investment Management Firms by Plan Sponsors Amit Goyal, Sunil Wahal (Journal of Finance Volume 63, Issue 4, printed August 2008)
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Combining active portfolios with indexed portfolios combines risk control with the opportunity to outperform
The returns of active/passive combinations fell between those of all active and all indexed portfolios Best
Rankings of semiannual returns, 19822009
Worst
Analysis of five possible portfolios in 56 semiannual periods during 19822009. A spliced indexthe Dow Jones Wilshire 5000 Index through April 22, 2005, and the MSCI US Broad Market Index thereafter was used as a proxy for a broad-market index portfolio. (Index performance does not reflect real-world operating costs, which could alter the results.) The active portfolios were combinations of Lipper fund category averages roughly approximating the market capitalization of the broad market. Past performance is no guarantee of future results. These hypothetical examples are not representative of any particular investment, as you cannot invest directly in an index or a fund-group average. Sources: Vanguard and Lipper Inc.
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Adding a broad market index fund dilutes alpha, but can temper the drawdown
Combining index and active strategies, maintains positive alpha, but truncates the extreme downside risk of active management
But the advisor faces a lesser risk of losing clients
Update resume Client pulls most assets Client pulls some assets Client asks questions
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Greater control of asset class risks Diversification Style consistency Tax advantages
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Conclusion
On average active management has not met investor expectations Index funds derive their long-term performance advantage from lower costs, style purity and the relative efficiency of the capital markets Despite the averages, opportunities do exist for active management to add value Combining index and active strategies can truncate downside risk and lead to improved client retention
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Disclosures
All investing is subject to risk. Diversification does not ensure a profit or protect against a loss in a declining market. Prices of mid- and small-cap stocks often fluctuate more than those of large-company stocks. Funds that concentrate on a relatively narrow market sector face the risk of higher share-price volatility. 2011 The Vanguard Group, Inc. All rights reserved.
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