Vanguard Early Young Transition Late Investment Perspectives

Vanguard

Investment PerspectivesTM

Summer/Fall 2017

Questioning retirement

plan design

Insights from Vanguard's head of advice Page 4

In this issue:

Cutting complexity A message from the head of our Institutional Investor Group Page 3

Preserving a source of diversification Why we hedge currency risk of non-U.S. bonds Page 7

Patient, not passive Our approach to active fund management Page 10

The long view Rates change but the role of bonds doesn't Page 13

Vanguard Investment Perspectives Summer/Fall 2017 Published semi-annually by The Vanguard Group, Inc.

Vanguard Investment Perspectives is designed to help institutional investors and consultants understand the investment philosophy and methodology behind Vanguard products and services. It is also intended to help institutional investors make their own investment choices.

Cover image: "Effective asset allocation: The Vanguard glide path" (detail).

Helping clients cut through the fog of

complexity

August 2017 When choosing the best investment solution for your organization, you face a formidable task. Already confronted with thousands of investment options, you're seeing more complex products, many in response to what's expected to be a low-return environment. These include mutual funds that incorporate leverage in new ways, target-date funds (TDFs) that invest in alternatives, and customized TDFs with glide paths unique to your plan's participant demographics. Distinguishing innovation from marketing spin can be difficult. We can help with analysis and thought leadership driven by a desire to do what's right for our clients. As an organization owned by its funds, which are in turn owned by its shareholders, we're uniquely committed to investor success. It's that commitment that's behind the launch of this investment newsletter. Intended to provide transparency into the review and analysis we conduct of the investment methodology behind our products and services, we hope the articles will help you make your own investment choices. In this inaugural issue, we pull back the curtain on the robust debate that takes place within our Strategic Asset Allocation Committee, which has responsibility for the investment methodology that guides our single-fund investment solutions and advice programs, including Vanguard Target Retirement Funds. Our CEO, Bill McNabb, writes about how, even in a rising-rate environment, bonds are an important part of a diversified portfolio. We also hear from Vanguard experts in a number of topics, including the potential pitfalls of incorporating alternatives into retirement plans and our approach to active management. We are confident these articles and those in future issues of this newsletter will help you filter out the noise--to separate those investments that are truly sophisticated solutions from those that are complex simply for the sake of being complex. Sincerely,

Martha King

Ms. King is managing director of Vanguard Institutional Investor Group.

Vanguard Investment Perspectives ? 3

Questioning retirement

plan design

in an ever-complex environment

Insights from Vanguard's head of Enterprise Advice

Shifting regulatory sands, low expected returns, and an aging population may pose problems for retirement plan sponsors, but participants still expect you to help them meet their retirement goals.

You still must determine the proper fund lineup, assess the effectiveness of a qualified default investment alternative (QDIA), and evaluate the suitability of choices through robust analysis and ongoing due diligence.

To better help you meet these and other responsibilities, Vanguard launched Defined Contribution Advisory Services (DCAS) in April 2016--part of an effort to deepen Vanguard's consultative dialogue with investment decision-makers in the defined contribution (DC) market, said Kevin Jestice. We asked him about DCAS and other topics, including customized target-date funds (TDFs) and considerations for incorporating active management into retirement plans.

Vanguard: Why did we launch DCAS?

Mr. Jestice: We hear a lot of questions around customization of TDFs, though few plan sponsors are moving to adopt custom funds. We hear a lot of questions around investment lineups: What's

the right way to build a menu? What are the right funds to have? How many funds do I need? We formed DCAS to help our clients think through these questions.

Vanguard: What are some of the questions we're getting around TDFs?

Mr. Jestice: How worthwhile is customization to a plan, given the plan's demographics? What are the real costs and benefits of customization, and how would one approach it? We built a new platform [Vanguard Glide Path SolutionsTM (Vanguard GPSTM)] to help answer these questions.

And we built the system to be agnostic. However, if you go into [Vanguard GPS] and build a custom TDF, what you find out is that the incremental costs relative to our Target Retirement Funds may be higher than the benefits. Clients are able to model and test things that they hear about and see for themselves.

Vanguard: Beyond TDFs, what are some of the issues that are top of mind for clients?

Mr. Jestice: We are beginning to see plan sponsors talk about trimming fund lineups in the third tier. [Vanguard suggests retirement plans cluster investments into three tiers: target-date,

4 ? Vanguard Investment Perspectives

core index, and supplemental.] There are fewer dollars there, yet much of their time is spent on oversight of that tier because that's where the active managers are. That's where the underperformance and outperformance is. That's where active manager turnover and succession planning must be considered. A lot of time and energy is spent in due diligence and oversight of tier three, and yet the majority of assets, and definitely cash flow, are heading toward the target-date and index tiers.

It's still an early-stage trend, but plan sponsors are saying, "We have 20 or 25 investment options in our plan. Let's bring that down a little. I'm not sure that's serving our investors that well."

Vanguard: Do you see the third tier eventually going away?

Mr. Jestice: There's a minority of plans that say, "I've got target-date funds, I've got some broadly diversified index funds and money markets for a cash account. That's it." It's a very simplified, streamlined approach.

But there are still a lot of participants who want to pick their own investments, pick their own managers, and have an active bent. That tier three enables participants to do that. You have to know the participant demographics to understand if you have a workforce that really values that. There are demographics of employees who want that tier, and there are other demographics of

Tier I:

Single-fund solutions (includes QDIA)

Tier II:

Core investments

Tier III:

Supplemental investments

employees who aren't interested and don't use it. That's a plan sponsor decision. The trend we're seeing is that plan sponsors are interested in reducing the total number of funds to reduce the due diligence time and resources spent on what is a shrinking percentage of the total plan assets.

Vanguard: Investors have been favoring index funds for some years now, and the trend seems to be accelerating. Is there still a place for active management?

Mr. Jestice: We certainly think so. This is much more about low cost than active versus passive. I strongly believe that active and passive can play a role in an investor portfolio.

Vanguard: How do we advise sponsors considering active management?

Mr. Jestice: We want to make sure participants have the ability to construct broadly diversified portfolios. If you're trying to build a nine-boxstyle tier three, then you need to fill more of the boxes than not. You can also take an alternative approach that says, I just want a few broadly diversified active U.S. equity funds, international equity funds, and fixed income funds.

Of course, with any active approach, it is also important to have conviction in the manager. This requires that a committee spend time understanding the approach. DCAS works with Vanguard's Portfolio Review Department to help committees with this, particularly for Vanguard's active funds.

The thing we have to have in the back of our minds is that a lot of people may employ heuristics to choose funds, which may not be optimal. For example, some investors follow the "1/n strategy" to allocate their portfolios.

They look at the fund lineup, and if there are 20 funds, they might invest 5% in each. I think it's hard for us sometimes as professionals to understand, but that's actually a fairly common heuristic in 401(k) savings.

Vanguard Investment Perspectives ? 5

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download