Bogle’s Allocation and Other Morningstar Conference Notes

Special Note: We’re announcing today that Fidelity Investments’ senior investment strategist Bruce Johnstone will be a keynote speaker at this year’s upcoming AAII Investor Conference. Johnstone was previously ranked as the #1 equity-income fund manager during his tenure as portfolio manager of Fidelity’s Equity-Income Fund. To see Johnstone and the other great speakers we have scheduled, be sure to register before the conference sells out.

How does the founder of the largest mutual fund company allocate his portfolio? John Bogle was asked this very question following a webcast presentation he gave at last week’s Morningstar Investment Conference. Bogle said that he continues to use 50% stock/50% bond allocation. He jokingly described himself as spending half of his time worrying about not having enough exposure to stocks and the other half worrying about having too much exposure to stocks.

He went onto to suggest that a good allocation range for most investors lies somewhere between 70% stocks/30% bonds and 30% stocks/70% bonds. Bogle advised finding an acceptable mix along this range and staying the course with it. His rationale for capping the stock allocation at 70% was that he doesn’t think most investors will be able to withstand the volatility associated with a higher allocation to stocks.

The subject of allocation also came up in two separate meetings I had with representatives of fund companies. (The Morningstar Investment Conference is a mutual fund conference geared primarily toward financial advisers.) Wyatt Lee, the co-portfolio manager of T. Rowe Price’s target-date funds, said he opts for a “through” approach for transitioning from working to retirement. A through approach gradually reduces exposure to stocks heading into and throughout retirement or a period of retirement. Lee uses an approximate 55% stocks/45% bonds allocation at the year retirement is scheduled (the date listed in the target-date fund’s name) and gradually decreases the fund’s allocation to bonds over a period of 30 years in retirement.

Lance Humphrey, the portfolio manager of global multi-assets at USAA Investments, uses a “to” approach instead. This approach allocates to a retirement date, at which point the allocation becomes significantly more conservative. Humphrey targets an allocation of approximately 30% stocks/70% bonds at retirement. He did add that ideally investors should adjust their allocations based on personal needs at and once in retirement.

Another source of disagreement occurred among two members of the same firm. This time the subject was the economy. Rick Rieder, BlackRock’s chief fixed-income officer, told a small group of us in the media room that gross domestic product (GDP)—which is calculated by the Commerce Department’s Bureau of Economic Analysis—is improperly measuring economic growth. He believes that the downward pressure being put on prices by technology and the corresponding growth in goods consumption (particularly recreational goods such as smartphones) is not being properly factored into the headline numbers. Roughly 75 minutes later, BlackRock’s CEO, Larry Fink, told the audience in a general session that his economic assessments differ from Rieder’s. He believes that many people in the U.S are waiting to see how things play out with the new presidential administration. He further argued that the United States’ current demographics makes achieving sustainable 3% economic growth seem “pretty improbable.”

One area where there was agreement was smart beta and so-called risk factors such as value, momentum, yield, volatility, etc. (Morningstar uses the term “strategic beta” instead of “smart beta.”)  Patrick O’Shaughnessy of O’Shaughnessy Asset Management and Wesley Gray of Alpha Architect both cautioned conference attendees to pay attention to what they are actually getting in smart beta funds. O’Shaughnessy said that smart beta funds should have a high level of active share, meaning that their portfolios significantly differ from market-capitalization-weighted indexes. Gray warned that overlaying too many factors gives you essentially the return characteristics of the S&P 500, but at a much higher cost. Gray, who prefers the simplicity of clean exposure to factors, does think an integrated strategy combining different factors could work if properly constructed. O’Shaughnessy cautioned, however, that such an approach should be closely looked at to ensure that the portfolio’s return characteristics are different than those of the market.

Finally, a few miscellaneous items of note from the conference. Bogle thinks it will be harder for active managers to outperform in the future, especially if rates of return are lower. He also argued that the growth in mutual fund assets has benefited the fund companies, but not mutual fund investors. Rieder suggested that yield-seeking investors consider including emerging market debt in their portfolios because the interest rates on such bonds are higher and are more likely to come down than go up in the future (creating opportunities for capital gains). Fink described the ability of active managers to outperform as being hindered by the increased flow of information. He also believes the recent outperformance by active managers is more attributable to macro bets than their ability to uncover information others don’t have. USAA has filed paperwork to launch ETFs. These ETFs would be available to all investors, not just USAA members. Finally, Michael Lewis discussed his latest book, “The Undoing Project” (W.W. Norton, 2016), which focuses on Daniel Kahneman and Amos Tversky’s relationship and their groundbreaking work on behavioral economics. (It’s a good read for those of you who are interested in the subject matter.  Movie rights have already been sold, according to Lewis.) When asked by Morningstar director of personal finance Christine Benz if he had plans to write another book about Wall Street, Lewis cautioned that doing so would mean “something bad happened.” Let’s hope his next several books focus on a  different topic.