A 15-Year Review

John Bogle, the founder of Vanguard and the man who gave the masses the first index fund, was reminiscing recently. In a talk he gave earlier this month, Bogle reviewed the lessons in a 15-year-old bit of investment advice. “I thought it would be fun, interesting, and provocative to examine what’s happened over the exciting era since I made my policy recommendations.” In particular, he revisited his recommendations from the summer of 1996 and “how they compared with the actual results of the average endowment fund tracked by The National Association of College and University Business Officers,” aka NACUBO.

Ever the skeptic, Bogle was cautious about reading too much into a rear-view mirror approach to investment analysis, even his own. “Perhaps we can learn something from that past, or perhaps not,” observed the author of several worthy investment tomes, including The Little Book of Common Sense Investing and last year’s Don’t Count on It!: Reflections on Investment Illusions, Capitalism, “Mutual” Funds, Indexing, Entrepreneurship, Idealism, and Heroes. But sometimes the basic facts do all the talking for you. Indeed, Bogle reports that the average endowment fund earned a 7.3% compounded return for the decade-and-a-half through this past June.
Meanwhile, Bogle summed up his 1996 recommendation as follows:

George Putnam and yours truly recommended a balanced approach. With bonds then yielding 7 percent and stocks but 2 percent, we both liked the concept of earning more income for endowments that must pay out returns to their universities, as well as the likelihood of substantially reduced volatility. I also urged endowment managers not to rely on “history and computers” to forecast stock and bond returns. My major recommendation couldn’t have been more specific: a 50/50 portfolio using U.S. stock and bond index funds, a balanced portfolio with extraordinary diversification and remarkably low costs—“on automatic pilot,” if you will. Simplicity writ large.

How did Bogle’s advice fare? He continues:

My principal recommendation would obviously have been best implemented with the lowest cost stock and bond index funds, so I had no choice but to rely on Vanguard Total Stock Market Index Fund and Vanguard Total Bond Market Index Fund, rebalanced each quarter to 50/50. Our institutional shares—net of all fund expenses—provided an annual rate of return of 7.1 percent—6.2 percent for the bond fund and 6.0 percent for the stock fund, itself a surprising outcome. (That the total portfolio provided a higher return than either of its components is explained by the quarterly rebalancing.)

Bogle’s recommendation, in short, trailed the average NACUBO result, if only slightly. But the performance looks somewhat better on a risk-adjusted basis, he notes. “The indexed portfolio had a standard deviation of annual returns of 8.9 percent, exposed to some 20 percent less risk than the 11.3 percent volatility of the average endowment. As a result, the risk-adjusted return of the 50-50 portfolio, measured by the Sharpe Ratio was 0.45, well above the 0.38 Sharpe Ratio for the average endowment.”
What’s interesting is that Bogle’s simple, perhaps even naive strategy turned out to be competitive with some of the best investment minds in the NACUBO universe over a fairly long stretch of time. The average figures no doubt mask some big winners among endowment funds (along with some big losers). But the outliers don’t tell us much, since most of the money was surely invested in and around the average performers.
I don’t have access to the data, but I’m willing to bet that most of the NACUBO funds’ returns cluster around the average. I say that based on numerous studies over the years that tell me that this is a fairly typical result when looking at a broad sample of portfolios. I’ve also crunched the numbers in various ways over the years and found similar results, including my ongoing comparisons of actively managed asset allocation mutual funds vs. my Global Market Index (GMI), an unmanaged benchmark that holds all the major asset classes in their market value weights. As I reported a few weeks ago, GMI boasts a competitive if not exactly stellar record against the sea of managers intent on doing better.
Bogle’s 15-year retrospective offers yet another bit of support for thinking that a bit of modesty can do wonders for a portfolio strategy. No, the lesson isn’t that we should turn our minds off and do nothing. But we should be mindful that there’s also lots of risk in going to the opposite extreme.
“Remember reversion to the mean,” Bogle concludes. Why? James Montier of GMO’s asset allocation team explains by noting that “reports of the death of mean reversion are premature.”

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