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No Magical Fountain of Alpha for Vanguard

CIO-elect Tim Buckley says Vanguard will stick to diversification and simplification on his watch.

Dan Culloton, 10/29/2012

Tim Buckley, who takes over as Vanguard's chief investment officer when Gus Sauter retires at the end of this year, has never worked as a securities analyst or portfolio manager, but he has been a CIO before. From 2001 to 2006, he was Vanguard's chief information officer and managed the fund family's programmers, software, and hardware. How does that qualify Buckley to lead the investment operations of a nearly $2-trillion-in-assets firm? Morningstar analysts asked Buckley, who has run Vanguard's Retail Investor Group since 2006, this and other questions in a recent interview. Here's the edited transcript:  

Q: Do you consider the CIO job that you are taking over more of an investment-management job or a management job?

A: I think it's--the way Gus has defined it--a leadership job, and he has done a fantastic job of building an investment team of more than 300-strong here. My job is to keep this going.

We don't make big macro calls at Vanguard. So, the CIO role here is a leadership role, and it's one that Gus has defined and I hope to pick up where he left off.

Q: You've called Gus a good keeper and defender of the Vanguard philosophy. Can you define, in your own words, your philosophy?

A: I bet you guys could do it right off the bat, right? In our product philosophy we look at products and say, "Are these long-term? Do they belong in a long-term portfolio? Are they enduring concepts?" Not, "Well, this will work really well this year, but not three years from now." So, there is long-term and there is enduring and there is low cost.

There are a lot of options out there with a lot of different strategies. They are just really expensive. You know we believe that costs are something you have to keep low. In a portfolio they just consume returns. We also ask, "Can we be best-in-class in that? Is this a great diversifier? Does it help simplify investment process for somebody?" These are elements of our strategy that we look at and we hold true to. They help define what products we'll come out with.

Q: We like to see someone with a great deal of investment experience as the head of an investment organization. What makes you and Vanguard different?

A: Twenty-one years at an investment company and being involved in the managing of the investment company, including the evaluation of outside advisors and internal advisors the whole time ... but if you want to get comfortable, come on in and sit with the team. Talk to (Vanguard head of fixed-income risk management) John Hollyer, who I would say is, in terms of risk management, outstanding. You can talk to (fixed-income head) Bob Auwaerter, you can talk to (taxable fixed-income head) Ken Volpert, you can talk to (global head of equities) Sandip Bhagat, (Asia CIO) Joe Brennan. We have assembled a team of professionals. You look at them, you say, "OK, I get it. It is not about one individual. It's about the team." The team--they are the ones that run the investment management here at Vanguard, not one person.

Q: Could you evaluate the environment in which you're taking on this role? What are the unique challenges that you see?

A: We're seeing behavior that you don't necessarily love in the broad market. Things like retirees taking too much risk because they are reaching for yield, or young investors not willing to take the risk to set themselves up for retirement. We spend a lot of time thinking about how do we get more people involved in what have been very successful target-retirement funds.

On the flip side, we look at retirees. How do we get them thinking not in terms of yield, but in terms of total return? Better to draw down a portfolio based off of total return rather than just going for a fund with a high yield. And you don't want people going to a high-yield bond fund or a high-dividend-paying equity fund just because they want a stream of income.

Q: What sort of trends can you see Vanguard investigating more closely? Can you see more alternatives?

A: I'm going to give you two categories: simplification and possibly diversification. I could argue that with four funds I could set up a portfolio for you that would last for 30 years and you'd be fine. That said, can we find other ways to diversify your portfolio, look for areas that are lowly correlated with equities? That's where alternative strategies come in.

The problem with alternatives is, well it's very difficult to find ones that aren't tightly correlated with equities in a downturn, that you can employ at low cost, that you can do without leverage. So, do we look at these other ways? Yes. Do we run some of our own internal models around them? Yes, we do and we'll continue to look at them ... There are plenty of avenues for us to explore, but we're driven to areas where we can improve your diversification. We're not trying to pursue some magical fountain of alpha. No, we're about taking your portfolio, diversifying it better, and making it easier for you to invest.

Q: What about low volatility or minimum variance indexes?

A: We're having a hard look at it, honestly. If you can minimize the volatility in some of these portfolios, especially in (investors') retirement years when they're drawing (their nest eggs) down, that could make a difference. That could make a big difference. So, I'd say more to come on that and definitely check back with us.

Q: Are there any areas in Vanguard's lineup that need improvement or attention?

A: We have a short-term TIPS fund coming out, so that you'll see very shortly (it launched Oct. 16), you'll see the international-bond and international emerging-markets bond funds (in 2013). I think those complement the portfolios very well.

In the ETF lineup, you've seen the most activity, but that was really catching up to where the rest of our indexes had exposure. Hopefully, the activity tails off a little bit now. We have a lot of funds out there, and I would challenge you to think of one that isn't long-term and enduring and that you couldn't build a portfolio with. But yeah, in the product development game we are closer to the end than we are to the beginning in the U.S.

Q: Your application for an ETF share class for the actively managed Vanguard Inflation-Protected Securities fund has been stalled for years, but would you ever consider launching active ETF shares for any other actively managed funds?

A: If you look on the equity side, it's really tough when we think about our outside managers because of the transparency requirements on active equity. It gets very difficult on the traditional guys. Plus, the other thing you have to look at on the active side is, is there plenty of capacity?

Once you launch an ETF, guess what, you can't close the fund. So, you better make sure when you are launching an ETF, there is plenty of capacity. So, on the active side, I worry about transparency and I worry about capacity. So, if it's a space where there is plenty of capacity, where you won't be hurt by showing your hand on a regular basis, we would consider it, but otherwise, look, we are fine going through the traditional fund method. It gives us more control. When the fund gets too big, we can actually close down on cash flow.

Q: What job of the many that you've had within Vanguard prepared you most for being CIO?

A: Being CIO before. Gus likes the joke that I am the only guy in the industry that has been CIO twice: on the information side and the investment side.

When I went into IT, I had a great team, but I did not have extensive programming courses in college. I was an economics major. I quickly realized that that team did not need me to code, they needed me to lead, and they needed me to look at that organization and say, "OK, well, we don't have a common way to develop software, let's make sure that we have a standard way to do it. What does our talent pipeline look like, our talent management process look like? Let's bring that in. How are we running this data center? What does our disaster recovery look like? How can we improve that going forward? What are we doing with the web? There is a huge opportunity on the web that we should be taking. How can we better take advantage of that?" And I looked much more for leadership opportunities than I did thinking, "I better bone up on my Java here and get into coding."

Q: How do you see, as a chief investment officer now, the role of technology in investment?

A: I think it plays a huge role. It's a great tool to free up. I believe in using technology to standardize the rote things that you do on a daily basis. If you can use technology wisely, you can give someone back 50% of their day and they can free up their gray matter to think about if there is a better way to trade this. Is there a better way to rebalance this portfolio? Let me research this issue a little bit more and say what's the difference in value between these two issues.

From a risk-control standpoint, how you use technology can get you those risk-control reports faster, giving you a better idea of when you want to take risk in a portfolio. When do you want to add risk and when do you want to pull back? Technology is a great enabler of all those things.

Dan Culloton is an associate director of fund analysis for Morningstar and editor of Morningstar's Vanguard Fund Family Report, a monthly newsletter that offers independent, no-holds-barred guidance on the pros and cons of this dominant fund family. Click here for a free issue of the Vanguard Fund Family Report.
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