Was an ETF.com interview on Tuesday with John Bogle some sort of April Fool’s joke?
With all apparent seriousness, the 84-year-old investor famed for the simplicity and parsimony of his stay-the-course indexing approach encourages investors to tactically allocate 15% of their portfolios from stocks to corporate bonds.
And that was enough to provoke a withering critique from market blogger Eric Nelson, an Oklahoma City-based registered investment advisor and principal of Servo Wealth Management.
The first of three main criticisms in the new blog post, “Befuddled by John Bogle’s Advice,” is Bogle’s recommendation that investors increase their risk exposure for what amounts to a mere sliver of higher expected returns.
Nelson faults Bogle for emphasizing the return advantage of corporate bonds relative to low-yield government bonds without mentioning the higher risk.
“A discussion of possible write downs or defaults in corporate bonds… is noticeably absent,” he writes, adding:
“Mentioning the fact that for over 80 years (since 1927), the realized return difference between higher-risk corporate bonds compared to lower-risk government bonds … hasn’t even been 0.5% per year? No mention of that either.”
Nelson also points out that corporate bonds tend to significantly underperform when the stock market declines (so in 2008, for example, corporates lost 3.1% when government bonds were up 12.4%), adding this coup de grace:
“I imagine that is something the market-timing bond investor may want to be reminded of before they decide to reach for that extra 0.5% of potential return.”
Bogle’s reach for yield in fixed income is bitter irony for Nelson, a value-oriented Dimensional Fund Advisors proponent, since Bogle is adamant in his rejection of Nobel Prize winner Eugene Fama’s view that small-cap and value stocks deliver higher expected returns than the plain-vanilla total stock indexes Bogle favors.
But Nelson points out that in that same time period since 1927, value stocks beat a total stock index by more than 2% annually, small-cap stocks did the same, and a combined small-value portfolio outperformed a total stock index by more than 5% per year.
What’s more, Nelson says the same pattern is observed in both developed and emerging markets in recent decades.
“Think you need highly engineered institutional class mutual funds inspired by Fama to achieve those results?” the DFA advisor asks. “$1 invested in Vanguard’s own Small Cap Value Index Fund (VISVX) since its inception in 1998 has grown to almost $4 vs. barely $2 for the Vanguard Total Stock Index fund (VTSMX).”
But while tilting a portfolio for corporate bond crumbs at higher risk yet refusing to reach for more substantial equity returns seems unwise to Nelson, it’s the apparent abandonment of stay-the-course investing that constitutes his third criticism of Bogle’s April 1 interview.
Asked whether investors should protect their gains after a five-year bull market (presumably by exiting the market), Bogle offers a nuanced, or perhaps contradictory, response:
“People aren’t going to know how to do that — it’s market timing," Bogle is quoted as saying. "I’d say, never be out of the stock market. It just makes no sense to me whatsoever. But maybe you can trim taking 15 percentage points off the table or something like that.”
To which Nelson responds:
“A dramatic 15% shift goes well beyond rebalancing into the realm of tactical allocation — making sizable portfolio bets in reaction to past events or based on forecasts about the future,” he writes.
The lesson Nelson learns from the interview with Bogle, whose “cult-like following” has “hundreds of thousands of individual investors hanging on his every word,” is to “trust a philosophy, not a person” who “can easily be swayed by prevailing market sentiments.”
That is why fiduciary advisors typically require their clients to establish investment policy statements (IPS).
“When urges to make changes or follow the crowd present themselves, revisit your IPS and remember that your portfolio is based on your unique goals, objectives and risk tolerance, not off-the-cuff comments or market-timing calls from prominent industry professionals,” he writes.
Ignore the temptation to “just do something,” his blog concludes.
Reached by ThinkAdvisor, Nelson acknowledged some reluctance to taking on Bogle but for the overriding investment principles at stake:
“I really don't mean to be nit-picky with this stuff, but sticking with a long-term investment plan ain't easy," he said. "And when those we perceive to be pillars of discipline are wavering, suggesting tactical moves and wholesale asset class changes without a full description of the risks involved, I think we need to call them out. Even if this causes a few of his devout followers to think twice about his advice and think a bit more critically about their own situation, I think it's worthwhile.”