Vanguard's decision to increase and broaden its exposure to international equities in its target date funds was to boost diversification, not expected returns, says John Ameriks
Christine Benz: Hi. I'm Christine Benz for Morningstar.com. Vanguard's target-date funds have always been very streamlined, but recent changes will make them even more so.
Here to discuss those changes is John Ameriks. He is Director of Investment Counseling and Research at Vanguard. John, thanks for being here.
John Ameriks: I'm glad to be here, Christine. Thank you.
Benz: So, a couple of changes announced over the past week that will actually make these funds even more minimalist than they were before. Can you talk about some of the changes that you're making?
Ameriks: Absolutely, and this is all about gaining efficiencies and broadening the diversification that's available in our target-date funds, and then more broadly in our Total International funds as well. But let me talk about target-date first.
As many folks know, in the Vanguard target-date funds, the international exposure historically had been derived from three funds that represented different markets, Emerging Pacific and Europe. The announcement we made today is going to involve exchanging the exposure that we are getting through those three funds and consolidating that in one fund, the Total International fund.
We think that we can make that change, and in that way give people a little bit more efficiency around how we get that exposure. For example, you've got one fund that tracks, now the MSCI Equity Ex-U.S. benchmark, which is a very broad-based benchmark. We won't have these issues with graduation in terms of when a country moves from an emerging category to either the Pacific or the European category. That won't happen now. So there are efficiencies that we're going to pick up that way.
We're also as part of this change, an earlier change we announced, change the benchmark to the MSCI Equity Ex-U.S. That means that the exposure in the international fund now includes a broader selection of countries; importantly, Canada and Israel are in that index, as well as we go deeper into the market capitalization. Basically, growth in global markets and efficiencies in terms of how we can operate these things is going to allow us to do that at what we expect to be the same expense ratios we currently have in the funds.
Benz: Okay. So, another change is that you are nudging up the international equity allocation within these portfolios. Can you discuss the thinking that went on behind that decision?
Ameriks: Sure. So this is something that actually we've been looking at and doing analysis on for many, many years now. In fact, if we go back to 2006, Vanguard had produced a paper on exactly how much international should someone hold, and the answer to that question was between 20% and 40% is what we thought was reasonable for an investor to hold.
We're moving to 30% of the equity allocation in the funds, which will be allocated non-U.S. So it was 20, we are going to go to 30; that's right in the middle of our range. And basically it reflects the growing size of the non-U.S. market, the transactional efficiencies that have basically increased over time in terms of investing outside of the United States, and a desire for broader diversification.
This is not about a difference in expected returns. We still take the view that over the very long horizons that someone who is in the target retirement fund needs to think about that U.S. versus a broadly diversified non-U.S. portfolio are going to generate roughly the same amount of return. It really is about diversification to make you sure you are getting exposure to as much of the global economy as you can.
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Benz: So, John, your portfolios, the target-date portfolios, have always been notably minimalist in that they have not included some of these categories that appear in other target-date fund, so foreign bonds and commodities, for example. Should someone read that to mean that you don't necessarily need those categories in your portfolio? What's your take on those asset classes?
Ameriks: Well, you know, these asset classes are things that we continue to look at, and we continue to ask the question of exactly how much benefit would there be to adding different types of asset class exposures, like non-U.S. bonds, like commodities.
As you mentioned, for the Vanguard Funds, there's really sort of four hallmarks, I would say, is transparency, the sort of passive index-based nature, low costs, and the relative simplicity of the construction. That really is important for us.
There are some asset classes that we think could potentially help us with that. It's just a matter of can we get all four of those things in one place. And with something like commodities, you probably have seen a lot of the press lately. A lot of people still don't quite understand what they've got when they've got especially commodities futures exposure. And I think that's something that we're still keeping an eye on and still need to get a lot more comfortable with.
There are also, frankly, issues around implementation, in terms of commodity indices and futures products now, and regulators are very concerned about these derivatives and so there are some issues that we need to work through there.
In terms of international bonds, in these portfolios you've got an international exposure already. You've got a very broadly diversified fixed income exposure. Our simulations tell us there is not a tremendous amount to be gained or lost by adding international exposure, and it does complicate the structure.
So, right now, we are not moving in those directions, but there are things that we continue to look at.
Benz: Okay. Thank you, John. Thanks for sharing your insights. We appreciate it.
Ameriks: No problem, Christine.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.
