Vanguard Warns Off Those After a Quick Buck
Add Vanguard Group Chairman John C. Bogle to the list of nervous Wall Street pros trying to yank the punch bowl from the stock market’s party.
Worried that Vanguard’s stock-index mutual funds are attracting too many investors who are only chasing short-term gains, the company is sending a cautionary letter--penned by Bogle--to all recent buyers of the funds and to people who ask for information about them.
“We are concerned . . . that a number of investors may simply be focusing on the recent strong performance of the Trust’s portfolios--the wrong reason to invest in the Trust,” Bogle says in the letter. “Investors attracted by recent short-term results may well be disappointed by shifting market conditions,” he warns.
Valley Forge, Pa.-based Vanguard, one of the country’s biggest mutual fund firms, is best known for its index funds. Instead of trying to beat the market, these funds simply seek to mimic the performance of major sectors of the market.
The central idea, of course, is that it’s smarter to accept the average return on stocks over time than to take the chance of investing with a manager who tries to beat the average--but fails miserably through lousy stock-picking.
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Vanguard’s largest index fund is its 500 Portfolio, which is designed to replicate the return on the Standard & Poor’s 500 index of major blue-chip stocks. And it’s the 500 Portfolio that worries Bogle the most, because that fund got 80% of the $1.4 billion in net cash flow into Vanguard’s index funds between January and May.
In the letter, Bogle notes that the S&P; 500 index, now up 20% year-to-date, had performed better than 93% of all general stock funds in the first five months of this year. While those spectacular results are undoubtedly helping to lure more and more investors to Vanguard’s 500 Portfolio, Bogle points out that “the 1995 experience has been unusually favorable” for the S&P; 500.
From 1991 through 1993, for example, the blue-chip S&P; 500 badly lagged the average stock fund because many fund managers were loaded up with shares of smaller firms, which were much more in vogue on Wall Street in that period. In 1993, the S&P;’s 10.1% gain beat only 40% of general stock funds.
Or put another way, 60% of “active” fund managers did better than the S&P; in 1993.
Bogle’s point is that the market is constantly running through cycles, and that for now the S&P; stocks are way out in front--but it won’t always be thus. So he’s trying to warn away wide-eyed investors who may be expecting another 20% return in the short run.
Bogle’s motives aren’t entirely altruistic. What Vanguard fears is that its 500 Portfolio is now attracting “hot money” investors who will exit as fast as they’ve entered if the stock market cracks.
That could wreak havoc with the $11-billion fund’s operations by forcing Vanguard to buy, then quickly sell, a hoard of S&P; stocks, thus running up trading and operating expenses. Anybody who knows Vanguard knows that one of its hallmarks is penny-pinching: The company prides itself on keeping expenses low, which is particularly crucial for an index fund if it’s truly going to track the return of the index it’s supposed to replicate.
In the letter, Bogle reminds investors that Vanguard’s index funds don’t allow telephone exchange privileges--which means panicked investors wouldn’t be able to call the company in the midst of a market plunge and give an immediate sell order. You’d have to do that by mail, a process that takes several days.
“In sum, if you have a short-term investment horizon, or if you wish to redeem your holdings on any sign of market weakness, Vanguard Index Trust is not the right investment for you,” Bogle tells investors.
Will that letter really stop the “wrong” people from buying Vanguard’s index funds? A true short-term trader might give pause, but most fund buyers today probably believe in their hearts that they’re investing for the long haul. The trillion-dollar question is, how many of those declared long-term investors will quickly compress their time horizons if the stock market starts to go down in flames?
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The S&P;’s Hot Hand
Through May, the S&P; 500 stock index had outperformed 93% of general stock funds this year--the best showing for “passive” index investing in at least 11 years. Percentage of general stock funds beaten by the S&P; each year: 1995: 93%*
* Through May
Source: Lipper Analytical Services
