Is Bogle Befuddling?

Take That, Jack
Eric D. Nelson, CFA, headlines in his company blog that he is "befuddled by John Bogle's advice." That caught my attention. Whatever Bogle's sins might be, that of confounding would not seem to be high atop the list.

Nelson takes aim at three recent Bogle recommendations. In an interview dated April 1, 2014 (yes, I wondered that, too, but the article is real), Bogle suggested that investors: 1) own corporate bonds rather than the Treasury-heavy  Vanguard Total Bond Market Index (VBTLX); 2) hold the entire equity market, rather than favor value stocks; and 3) consider reallocating up to 15% of their portfolios from stocks to bonds.

Nelson is puzzled. The first two items appear to be in direct conflict, as Bogle advocates buying a portion of the bond market but owning the whole stock market. The third idea strikes Nelson as worse yet--tactical allocation, known less politely as market-timing. Nelson points out that Bogle has devoutly supported a "stay-the-course approach," but now seemingly advises, "Don't just stand there, do something!" Irony, thy name is Bogle. 

Nelson has a point. It is at odds to hold the entire stock market but only part of the bond market. Also, shifting up to 15% of one's assets from stocks to fixed-income based on current market conditions does appear to be a form of market-timing (as Bogle himself confesses in the article). 

And yet ... I think not. For one, Bogle is not an investment manager. Nor is he a CEO. He is an author who has a personal portfolio. As such, he is bound neither by prospectus nor by company policy. It's natural that he might have a few idiosyncratic views.

After all, back in the day, when Money asked Harry Markowitz about his personal asset allocation, Markowitz replied that it consisted of 50% stocks, 50% bonds. That seemed a remarkably round number to the Money reporter, who inquired how the former physics major and father of quantitative investment theory arrived at that figure. Simple, answered Markowitz. If he split his portfolio evenly between the two assets, then he would never regret having most of his money in the asset that was currently losing.

That wasn't how I would (and do) invest, nor did it line up with Markowitz's theories, but Markowitz wasn't hired to run other people's money. He had the task of managing his own assets, and as with any good advisor, he listened to his client. The most important risk for that particular client was the opportunity cost of owning a relative loser. So, Markowitz structured the portfolio appropriately.

Also, Bogle's recommendations are really not so idiosyncratic. 

In underweighting Treasuries, he is thoroughly in the current consensus, as nearly every general bond-fund manager is doing the same. As Nelson points out, Treasuries are a portfolio's insurance feature. When the economic times get tough, Treasuries get going, even as high-quality corporate bonds tend to struggle. So, most investors probably won't wish to drop Treasuries completely. But Bogle mostly talks about tilting, not eliminating. 

There is, of course, nothing odd about indexing the entire stock market. In addition, if Bogle is guilty of inconsistency in indexing all stocks but not all bonds, so, too, is Nelson in advocating the opposite. After all, Nelson would have people hold their full Treasury allocations but not their full growth-stock positions. Pot, meet kettle. 

As for Bogle's most-radical idea, that investors might wish to rotate out of stocks and into bonds, it's not radical when one considers what Nelson freely acknowledges: that Bogle isn't much for rebalancing. A portfolio that consisted of 50% stocks, 50% bonds in spring 2009 that has been permitted to run with the market will now be 65% stocks, 35% bonds. Thus, shifting 15% of assets from stocks to bonds would put that portfolio right back where it started. That's not market-timing; it's a giant rebalancing. Irony, thy name is not Bogle.

Nelson's investment views seem fine to me. As do Bogle's. That they conflict at times, and that each party might think the other is slightly dotty, does not perplex me. 

In Praise of the Ordinary
The investment performance of another, less-revered gentleman has also been in the news. The press has breathlessly reported that, if forced to sell the Los Angeles Clippers, Donald Sterling could receive as much as $1 billion, thereby reaping a "massive profit" on an initial investment of $12.5 million made in 1981.

Indeed, Sterling will end up doing very well indeed on the Clippers, earning just more than 14% annualized for the 33 years. However, had he put that money instead into  Vanguard 500 Index (VFIAX) shares, he would have still made a healthy 11.1% per year, taking him to about $400 million. That strikes me as impressively close, given that Sterling assumed huge idiosyncratic risk in putting that $12.5 million into a single egg and given that the investment was unusually successful, even by the standards of professional sports franchises. 

Also, Morningstar's Paul Justice reminds me that there were better-performing U.S. stock indexes than the S&P 500 over that period. For example, Wilshire's Small Value Index gained 13.3%, its Mid Value Index made 12.7%, and Russell's Mid Cap Index managed 12.5%. Heading abroad, MSCI's Nordic Countries Index was closer yet to Sterling's result, at 13.7%.

Yes, Sterling fared better as a multimillionaire making a private purchase than did the masses buying an index mutual fund. However, the result was closer than most believe. 

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.