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The Independent Adviser for Vanguard Investors
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September 2015
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FOR CUSTOMER SERVICE, PLEASE CALL
800-211-7641
about 70% of the portfolio is in gov-
ernment securities, but it also includes
corporate and securitized issues. And,
as the name implies, it excludes bonds
denominated in U.S. dollars. That said,
once the bonds are purchased, the
managers hedge their foreign currency
exposure back to the greenback.
Removing the currency aspect gives
the index more of a pure bond feel—at
least in the sense of feeling like the
U.S. bond market. The bogey’s MCL,
a 6.3% drop, was only a bit steeper
than Total Bond Market’s 5.8% decline.
However, it was much more palatable
than the -18.0% MCL of the unhedged
version of this index.
Total International Bond has got-
ten off to a good start, outpacing Total
Bond Market 8.7% to 4.5% since incep-
tion. But I am not as quick to jump on
the bandwagon as Vanguard is. Using
historical data for the Barclays index,
Jeff and I didn’t find much advantage,
from either a risk or return perspective,
to mixing hedged international bonds
with a typical U.S. bond allocation. We
think the benefits here are more from a
marketing perspective than an invest-
ment perspective and have been way
oversold.
Emerging Mkts. Gov’t Bond Idx.
Buy.
Of Vanguard’s two international
bond funds launched in late May 2013,
this is the more interesting one, focus-
ing on bonds issued by governments in
emerging markets. The fund tracks the
Barclays Capital U.S. Dollar Emerging
Markets Government RIC Capped
Index, which covers over 800 securities
and is dollar-based, so again, investors
aren’t exposed to currency risk.
But this isn’t your typical bond index
fund if all you know is the U.S. mar-
ket. Take, for example, its benchmark’s
MCL of -34.5%, reached in August of
1998, largely the result of the devalua-
tion of the Russian ruble and subsequent
default. The index dropped 29.8% in
one month. Since early 1993, when data
for the index starts, there have been 15
months when this index dropped 3.5%
or more in a single month—something
the U.S. bond market has not done once
over the 23.5 years.
Still, courageous investors have been
amply rewarded over time for the risks
taken in emerging markets bonds. With
a return of 628% since the end of
December 1992, an index very similar
to this fund’s bogey has trounced the
return of Total Bond Market (242%)
and has kept just ahead of
Total Stock
Market
(607%).
Emerging Markets Government
Bond
is off to a relatively slow start,
gaining only 3.4% compared to Total
International Bond’s 8.7% return, as
concerns surrounding China’s slow-
ing growth and tumbling commodity
prices have dampened investors’ appe-
tite for emerging markets. The fund’s
4.67% yield, however, is well ahead of
Total International Bond’s 0.98% and
more than double Total Bond Market’s
2.12% yield, so there is potential here.
That said, I wouldn’t want you to think
I expect the fund to keep pace with the
stock market.
TheTaxThing
Bonds are complicated, as you no
doubt have come to realize over the past
few months. One final issue we should
talk about is taxes. Vanguard has a stable
of excellent tax-exempt funds, which I’ll
get to next month. Until then, I encourage
you to review the tax-equivalent yield
information on page 9 to determine if it
makes more sense for you to use a taxable
or tax-exempt option. Just remember that
when comparing taxable and tax-exempt
funds, you should look at funds with
comparable maturities (or durations).
More next month—stay tuned.
n
QUOTABLE
How Do You Spell “Security”?
WHAT DO VANGUARD, TARGET CORP. AND THE IRS have in common? All three are low-cost
providers who’ve faced public cyber security issues. Now, to be clear, Vanguard has not been
hacked and client data has not been lost to the best of our knowledge. However, one Vanguard
employee feels the company could be doing much more to protect our information and assets,
and after failing to generate enough concern inside the company, she took her worries public.
Karen Brock, a client relationship manager who serves 640 of Vanguard’s Flagship clients, has
called Vanguard out, filing a whistleblower tip with financial regulators at the SEC and FINRA.
Brock’s complaint is that Vanguard is not doing enough to prevent outsiders from accessing client
accounts. Brock identified a number of weaknesses in Vanguard’s security system. Clients were
able to access accounts online after misspelling answers to security questions. The son of one
client was able to impersonate his father and trick Vanguard’s voice verification system. Brock
also found client information published in training manuals.
Vanguard’s response has been about what I expected: “…we remain confident in our secu-
rity practices and efforts to keep our clients’ confidential information and their assets safe.”
This isn’t just the typical response from Vanguard, but seems to be the standard line when
questioned about security. Given how much of our lives have moved onto the web, it would
be refreshing to see a company stand up and really take ownership of both their problems and
solutions as they relate to cyber security. Unfortunately, I don’t expect that company will be
Vanguard, which, you may recall, had almost nothing to say about a series of letters sent to bro-
kerage clients from a former service provider, a tale I recounted in the December 2014 letter.
With more than $3.0 trillion in assets under management here in the U.S. alone, there is no
excuse for Vanguard not to have industry-leading security. But this could well be a situation
where Vanguard’s low-cost structure is more of a handcuff than an advantage. As I’ve said
before, you can’t be the low-cost provider without cutting corners and costs somewhere.
At the end of the day, neither Jeff nor I are pulling our money from Vanguard over this, but
while Vanguard works through this latest security issue, there is something you can do immedi-
ately to better secure your own account: Opt in for two-step verification. This means that you’ll
need your password
and
a unique six-digit code, which Vanguard sends you via text message
every time you attempt to access your account. It’s not foolproof, but it is an added layer of secu-
rity that both Jeff and I use for our Vanguard accounts and recommend you adopt for yours.