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The Independent Adviser for Vanguard Investors
•
April 2015
•
15
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ten off on the right foot. It has had a
tailwind behind both components of
its approach as lower-volatility sectors
and stocks have been in favor and the
dollar has strengthened. (Technically,
the fund doesn’t actually benefit from
a strengthening dollar—it should be
agnostic to changes in currencies—but
it is a relative benefit, as its peers, which
do not hedge currencies, are hurt by a
strengthening dollar.) The fund won’t
always have both oars in the water,
but I still think it could be a practical,
lower-risk option for adding foreign
stock exposure to a portfolio, particu-
larly for a conservative investor—and I
am upgrading it to a
Buy
.
As always, coming in with the
right expectations is crucial. Global
Minimum Volatility aims to win by
losing less, and like
Dividend Growth
,
looks to earn its keep in bear markets.
It is not a miracle fund, though, so if
stocks are declining, expect this fund to
be down as well. In bull markets, expect
the fund to lag—if it does keep up with
traditional indexes in a bull market,
consider that a bonus.
I do think the currency hedging is a
bit of overkill, and probably is a drag on
performance in the long run. Be aware
that the currency hedge is also going to
cause the fund to look out of step with
most non-hedging peers.
At Vanguard, the logical comparison
fund is Total World Stock Index, but as
we showed, Global Minimum Volatility
is managed and allocated differently,
so we should expect performance to be
different, too. That means that even if
the fund delivers on its objective of gen-
erating stock-like returns with less risk,
it will take discipline for an investor to
stick with it.
Flying in the face of conventional
investment wisdom that lower risk results
in lower returns and higher risk leads to
higher returns, back-tested data on a
minimum volatility strategy has shown
an ability to deliver returns in line with
the broad stock indexes with less risk
over a full market cycle
. I’m not quite
ready to dive in deep and buy the fund
for my
Models
, but Global Minimum
Volatility may be the best of Vanguard’s
global fund options today.
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Currency Hedging
WHEN YOU BUY A STOCK on a foreign exchange, there are two components to the return you’ll
receive. One, of course, is how the stock performs, just like buying a stock here at home. But the
second component is how the currency in which the stock is valued performs against your home
currency, which for most of us is the almighty U.S. dollar. Say we have two investors, a Japanese
investor and a U.S. investor. Both buy stock in Toyota—the Japanese automaker—on the Tokyo
stock exchange at the end of 2013 at a price of 6,420 yen per share. Given the exchange rate, the
U.S. investor pays the equivalent of $60.97. They both sell the stock a year later for 7,558 yen.
The Japanese investor made 17.7% on the stock—end of story.
But for the U.S. investor, that 7,558-yen share price is now equivalent to $63.14, because the
dollar has appreciated over the course of the year against the yen. The U.S. investor only earns a
total return of 3.6%. This is where the currency risk factors in.
Currency hedging is an attempt to remove (or at least reduce) the impact of changes in the
currency from the equation. Mutual fund managers can do this by entering into an agreement
to exchange a certain amount of one currency at an agreed-upon rate at a specified time in the
future for another currency. With the exchange-rate risk eliminated, the returns will only depend
on the stock’s performance.
Vanguard has not said how much currency hedging added to the performance of Global
Minimum Volatility since it was launched, but I think it behooves them to disclose this data,
given the fund’s objectives.
Foreign stocks look even less bub-
bly. Over the same bullish period,
Total International Stock
is up 15.4%
per annum, but since its own 2007
peak, it’s actually produced an annual-
ized loss of 1.2%.
I’m not surprised if you’re feeling
pushed and pulled by the myriad com-
mentaries about market peaks that per-
meate the media. Many commentators
already have a view, bullish or bearish,
and then pick the data point that sup-
ports their stance. I would say it’s a fair
guess that the next six years won’t see
returns as strong as the last six—in fact,
it’s probable there will be a bear market
sometime during the next six years.
But just because we’ve had a good run
doesn’t mean we are poised for a crash.
Whatever the crystal-ball gazers tell
us, you won’t see me changing my
stripes. I’m not about to become a mar-
ket-timer, jumping in and out of stocks
and cash. I’ll continue to partner with
the best managers at Vanguard. And
while I’ll occasionally shift the portfolio
toward areas where I see relative value
(see page 3 for the details of several
trades I recommended in the March 19
Hotline
to boost our allocations to over-
seas shares), I know that the best way
to build wealth is to spend time in the
markets, not time the markets. This
approach has served you and me well
over the more than 24 years I’ve been
writing this newsletter, and will continue
to, regardless of whether the current bull
continues to run or takes a breather.
With the first quarter now in the
rearview mirror, are there any trends
or insights that we can take away?
The clearest one to me is the value of
diversification, which is something I’ve
harped on again and again and again
over the years. Despite the strong dol-
lar, our investments in foreign stocks—
mostly through
International Growth
,
which is up 5.5% this year—have
helped the
Model Portfolios
produce
returns ranging from 2.4% to 3.8% for
the year versus
Total Stock Market
’s
1.8% gain.
Looking ahead, I’m expecting a fairly
lousy earnings-reporting season. The
reason: Given the fact that the S&P
500 is, by definition, top-heavy with
the largest companies in the market and
that many of these companies are
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