Speaker 1: This is Master's in Business with Barry rid Holds on
Speaker 1: Bloomberg Radio.
Speaker 2: This week on the podcast, I have an extra special guest,
Speaker 2: Greg Davis, chief investment officer at a little shop called
Speaker 2: the Vanguard Group, which manages eight trillion dollars. He's only
Speaker 2: responsible for seven point three trillion of it, so kind
Speaker 2: of a slacker. I found this conversation to be absolutely
Speaker 2: a masterclass in how to think about investing risk, how
Speaker 2: to think about where your returns come from, what sort
Speaker 2: of behavioral problems lead to bad outcomes, and all of
Speaker 2: the usual things that we've learned over the years from
Speaker 2: the success of Vanguard. Few people are in a position
Speaker 2: to see what's going on in the world of investing,
Speaker 2: whether it's institutional or retail, better than Vanguard's CIO, and
Speaker 2: Greg Day just does an amazing job. I thought this
Speaker 2: was a really fascinating conversation. I think you will also
Speaker 2: with no further ado, my interview with Vanguard CIO Greg Davis.
Speaker 2: Greg Davis, Welcome to Bloomberg.
Speaker 1: Thanks very great to be here with you.
Speaker 2: Great to have you. So let's talk a little bit
Speaker 2: about your background, which is kind of interesting. Undergraduate you
Speaker 2: get a BSN insurance from Penn State. What led to
Speaker 2: an interest in insurance.
Speaker 3: It's a long story, but originally I went to school
Speaker 3: for engineering. Got to school, realized that I wasn't very
Speaker 3: good at mechanical drawing, which is a big part of
Speaker 3: aerospace engineering curriculum. So I started to look at other
Speaker 3: opportunities and primarily in a business space, so start examining
Speaker 3: opportunities in finance, real estate, and insurance. Penn State was
Speaker 3: one of the few schools that actually had an insurance major,
Speaker 3: and you know, with the goal of actually getting becoming
Speaker 3: gainfully employed. When I graduated college, I thought, hey, having
Speaker 3: a a somewhat unique background would be helpful and it
Speaker 3: worked out. And had multiple job offers coming out of
Speaker 3: school from a number of different insurance companies and had
Speaker 3: an opportunity to be an underwriter for a few years
Speaker 3: before I decided to go back to school to get
Speaker 3: the NBA.
Speaker 2: How'd you end up at Merrill Lynch in the nineteen nineties,
Speaker 2: So I ended up going through the Wharton program.
Speaker 3: I did an internship in the summer at City Bank
Speaker 3: Securities and fixing come sales and trading, got a couple
Speaker 3: different job offers across the Street. But the reason I
Speaker 3: went to Meryl was because they had this unique global
Speaker 3: debt rotation program that allowed you to rotate through a
Speaker 3: couple of different business units in fixingcome sales, and trading,
Speaker 3: and I knew I wanted to do trading.
Speaker 2: Were you at the Downtown the World Final Financial by
Speaker 2: the way, that could be the most amazing trading desk.
Speaker 2: I've been there a couple of times, and in the
Speaker 2: nineteen nineties, when you walked onto the equity floor, you
Speaker 2: were just hit with a wall of sound and energy.
Speaker 2: I've never seen or experienced anything like that anywhere else.
Speaker 3: And the fixed income floor was equally sized, just on
Speaker 3: a different floor, but also a similar type environment. But
Speaker 3: it was a very interesting place to start a career
Speaker 3: after grad school. But that experience got cut short because
Speaker 3: right around that time when my class started, it was
Speaker 3: the tail end of the Asian financial crisis, the.
Speaker 2: Russian roue seven or ninety eight.
Speaker 3: I started in the beginning of I started in September
Speaker 3: of ninety eight, and that happened in ninety seven, but
Speaker 3: you had the Asian financial crisis, the Russian ruble devaluation,
Speaker 3: and then you had long term capital management blowing up.
Speaker 3: So there was a lot of changes that was happening
Speaker 3: across the street in terms of you know, layoffs happening,
Speaker 3: and our program got cut short, ended up getting placed
Speaker 3: in a non trading role, and you know, decided to
Speaker 3: look at other opportunities outside and came across this great
Speaker 3: opportunity to pursue trading at Vanguard, you know, twenty four
Speaker 3: years ago.
Speaker 2: So let's talk about that, and your bio explains how
Speaker 2: you were recruited to Van Guard. I thought that was
Speaker 2: a really interesting story. Tell us a little bit about
Speaker 2: what brought you to Vanguard.
Speaker 3: So it was interesting because I was pretty pretty keen
Speaker 3: on staying in New York. I had a number of
Speaker 3: relationships that I built up and had another job lined
Speaker 3: up in New York City. But one of my best
Speaker 3: friends that I grew up with actually worked in the
Speaker 3: HR department at Vanguard, and she was like, you should
Speaker 3: come down and talk to some people at Vanguard, And
Speaker 3: at first I kind of blew it off, but she
Speaker 3: was pretty persistent. So I came down, met with our
Speaker 3: head of the portfolio review department, which oversees our external managers,
Speaker 3: met with our head of brokerage, and then met with
Speaker 3: the head of Bond Indexing, who was Ken Volpert at
Speaker 3: the time, and me and him had an instant connection,
Speaker 3: and so Ken was the main reason I came to Vanguard.
Speaker 3: Vanguard had a great reputation already we were much smaller
Speaker 3: at the time, but Ken had a track record of
Speaker 3: bringing new people onto his team, developing them and seeing
Speaker 3: them move into bigger jobs over time. And as somebody
Speaker 3: who was relatively new to the industry, that's the kind
Speaker 3: of mentor and boss I was looking for. So, you know,
Speaker 3: Ken ended up being, you know, one of the best
Speaker 3: bosses I've ever had in my career.
Speaker 2: We'll talk a little bit about leadership and crew development
Speaker 2: a little later. It's really a fascinating subject. But you
Speaker 2: eventually serve as director of Vanguard Australia and Asia Pacific
Speaker 2: and CIO of the region. Tell us a little bit
Speaker 2: about that experience in the two thousands, I mean, the
Speaker 2: nineties was its own unique animal, but the two thousands
Speaker 2: certainly weren't boring.
Speaker 3: Now, So my family and I we moved to Melbourne,
Speaker 3: Australia where offices. It was a just a fabulous experience,
Speaker 3: both professionally and personally. Just having an opportunity to work,
Speaker 3: you know, in a different country, embracing the Australian culture,
Speaker 3: but being part of the Asia pac region because at
Speaker 3: the time we had an office in Hong Kong as well,
Speaker 3: where we were starting up our ETF business. But it
Speaker 3: was a tremendous experience because I had started off in
Speaker 3: bond trading, worked my way into portfolio management and running
Speaker 3: the bond the nexting team for a number of years,
Speaker 3: and then it got asked to take this responsibility which
Speaker 3: was much broader. So I was a mile deep on
Speaker 3: a subject matter of bond indexing, but now I had
Speaker 3: the opportunity to lead an equity indexing group, the entire
Speaker 3: fixed income team, our investment strategy team that does research
Speaker 3: for our clients around portfolio construction, those types of things.
Speaker 3: But the other big part of it was having an
Speaker 3: opportunity to be on the Australian executive team that actually
Speaker 3: ran the business. So from a broadening standpoint, I'm an
Speaker 3: investment guy, but that was an opportunity to actually learn
Speaker 3: about the business, how Vanguard Australia operates in the ecosystem,
Speaker 3: how we're trying to market our products and services, how
Speaker 3: we're engaging with regulators, the media, the whole nine yards,
Speaker 3: and then also being part of the board of directors
Speaker 3: down there. So from a broadening standpoint, that experience was unbelievable,
Speaker 3: so valued every minute that I was down there. And
Speaker 3: unfortunately or fortunately depending on how you look at it,
Speaker 3: you know, the three to four year assignment ended up
Speaker 3: being thirteen months, but I got a great opportunity to
Speaker 3: come back to run the fixed income group as you
Speaker 3: had As you had mentioned, but the time in Australia
Speaker 3: was fabulous for both myself, my wife and the kids.
Speaker 2: Yeah. You know, what's really interesting is everybody tends to
Speaker 2: think of Wall Street and investing in finance in terms
Speaker 2: of the investing side, but the business side is really intriguing.
Speaker 2: There are a lot endless variety of business models and
Speaker 2: seeing how people operate that it's really an education one
Speaker 2: that I think a lot of people coming out of
Speaker 2: school don't think about goes. You think about the sexy things. Hey,
Speaker 2: I want to do venture capital, I want to do this,
Speaker 2: I want to do that. The business side is really
Speaker 2: quite fascinating and somewhat overlooked.
Speaker 3: That's very, very true, but it's also one of those
Speaker 3: things that you don't necessarily appreciate it until you've been
Speaker 3: doing a certain job for a while. So if you
Speaker 3: would have said to me, you know, when I first
Speaker 3: came out of grad school and you said to me, hey,
Speaker 3: I want you to go to the business side, you
Speaker 3: know I would have said, no, thank you, I really
Speaker 3: want to do trading and portfolio management. But you get
Speaker 3: to a point in your career where you feel like, hey,
Speaker 3: you've you've learned a lot, You've developed a team, and
Speaker 3: you're looking for new challenges and a chance to stretch
Speaker 3: yourself and grow and learn.
Speaker 1: And that's exactly what that opportunity provided.
Speaker 2: So now you eventually get you go to fixed in
Speaker 2: and then you're elevated to chief investment officer of all
Speaker 2: a vangroup. Take us through a day in the life
Speaker 2: or or a week in the life of Vanguard CIO.
Speaker 1: Well, it's a lot.
Speaker 3: I mean, there's a there's a tremendous amount of meetings
Speaker 3: and the way I would the way I would describe it, Barry,
Speaker 3: it's a mix. It's you know, client related, it's media
Speaker 3: like we're doing today. It's also being part of the
Speaker 3: senior team that runs Vanguard, the business of Vanguard right
Speaker 3: from a client strategy marketing standpoint, and then you know, overseeing,
Speaker 3: overseeing the the the investment team, So a variety of
Speaker 3: risk meetings, a variety of economic meetings. So it's a
Speaker 3: any given day could be slightly different, but it typically
Speaker 3: will capture those categories over time. And so you know,
Speaker 3: it's uh, there's there's always plenty of stuff going on
Speaker 3: in the marketplace and then the business that that that
Speaker 3: keeps us very busy.
Speaker 2: And you've now been with Vanguard for almost twenty five years.
Speaker 1: You have to be twenty four in November.
Speaker 2: So you're you're year away from a big milestone. That
Speaker 2: period very much encompasses Vanguard going from and admittedly successful
Speaker 2: but not enormous entity till you know, I think the
Speaker 2: two thousands, especially the financial crisis, changed how people thought
Speaker 2: about managed assets, indexing advisory versus transactional and Vanguard along
Speaker 2: with black Rock, have been two of the biggest beneficiaries
Speaker 2: of this. Tell us a little bit about what you've
Speaker 2: experienced over the arc of those twenty four years that
Speaker 2: you were really there as the company ramped up and
Speaker 2: then went they found a whole other gear and just exploded.
Speaker 3: Yeah, it's absolutely right, Barry I mean, it's been a
Speaker 3: lot in terms of, you know, just the changing perception
Speaker 3: in the marketplace of how investors invest right. And you're right,
Speaker 3: So you think back thirty years, you know, there are
Speaker 3: so many people who are focused on individual security selection,
Speaker 3: picking individual stocks and the reality is that you know,
Speaker 3: we know that's very difficult to do and outperforming a
Speaker 3: broader market. So does a big push for folks to
Speaker 3: get the appropriate level of asset allocation in a highly diversified,
Speaker 3: low cost way. And you know, the ETF the ETF rapper,
Speaker 3: you know, allowed people to get that exposure inexpensively holding
Speaker 3: it in a brokerage account. So it really provided a
Speaker 3: nice tailwind to folks in the indexing space who provided
Speaker 3: those products. In Vanguard, is you know, one of the
Speaker 3: big beneficiaries of that that migration away from individual stock
Speaker 3: selection to to broad based index exposure to.
Speaker 2: Say the very least. So let's discuss leadership and what
Speaker 2: you do to develop crew members and to identify and
Speaker 2: foster other people's leadership skills.
Speaker 1: Yeah, so it's a great question.
Speaker 3: You know, one of the things that we try to
Speaker 3: focus on is you know, as part of our interview process,
Speaker 3: you know, always trying to assess and gauge the the
Speaker 3: willingness and the interest for folks to develop the leadership
Speaker 3: competencies in addition to the technical competencies. So you know,
Speaker 3: when we think about our investment professionals, clearly they have
Speaker 3: to be technically sharp, they have to learn those skills
Speaker 3: to do their jobs day to day. But if they
Speaker 3: also want to be the head of a trading desk
Speaker 3: and lead a major function within our group or within
Speaker 3: broader vanguard, they also have to be really good at
Speaker 3: identifying talent, developing talent, maintaining really strong relationships, you know,
Speaker 3: being strategic thinkers and things of that nature. And so,
Speaker 3: you know, these are the types of things that we
Speaker 3: have a number of programs that we run to help
Speaker 3: us assess how people are progressing through that leadership journey.
Speaker 1: We help develop people on that leadership journey along the way.
Speaker 3: But the assessment process also allows us to figure out,
Speaker 3: you know, where people might have gaps and need an
Speaker 3: opportunity to go back and do a bit of a refresher.
Speaker 3: So you know, we've been very actively involved in that
Speaker 3: whole process for our investment professionals, and you know, it's
Speaker 3: paid off. It's paid spades in terms of you know,
Speaker 3: it helps us make sure that we're recruiting the right people.
Speaker 3: It helps us in terms of retaining folks because when
Speaker 3: you work for a great boss, you're motivated to stay
Speaker 3: at that firm because we know, you know, it's difficult
Speaker 3: to make a strong connection with the boss at times.
Speaker 3: And to the extent that Vanguard has great leaders in
Speaker 3: the seats and we feel like, hey, we have some
Speaker 3: of the coolest jobs that are available to people. You
Speaker 3: couple that with great leadership. I mean, it's a win
Speaker 3: win formula for long term success for our organization.
Speaker 2: That's really interesting. A lot of people in finance have
Speaker 2: been saying it's difficult to find people in this environment.
Speaker 2: What is Vanguard doing to keep the seats filled and
Speaker 2: make sure you have an ongoing source of talent coming
Speaker 2: to Pennsylvania.
Speaker 1: Yeah, so we are very heavily involved. We have you
Speaker 1: in our group.
Speaker 3: Specifically, we have the Investment Management Development Program where every
Speaker 3: year we have a cadre of summer interns as well
Speaker 3: as full time folks who just finished their undergraduate studies
Speaker 3: who come to us in a rotational program that gives
Speaker 3: them exposure to equities various points in fixed income and
Speaker 3: risk and our portfolio reviewed department as a nice entry
Speaker 3: point for people to explore and see what they really
Speaker 3: want to do. And so we just had a cadre
Speaker 3: that launched to their final placement earlier this week, and
Speaker 3: so there were seven individuals that span the range from
Speaker 3: risk to high yield trading to investment grade research. And
Speaker 3: you know, it's a nice talent pipeline. And the great
Speaker 3: thing is the talent that we're seeing today is so
Speaker 3: much greater than the talent that we were able to
Speaker 3: attract twenty years ago. And so, you know, just the
Speaker 3: level of awareness, understanding of markets, the technical skills from
Speaker 3: an IT and data science standpoint that these folks are
Speaker 3: bringing to the table today is pretty amazing. And so
Speaker 3: that's really the pipeline for us. And then you know,
Speaker 3: we will supplement that with experienced senior hires, you know,
Speaker 3: as we you know, if there's turnover and we don't
Speaker 3: have somebody on a bench ready to go to move
Speaker 3: into a bigger seat as well, or if we're trying
Speaker 3: to build that new capabilities like we've done in the.
Speaker 2: Past, huh, really impressive. Let's talk a little bit about
Speaker 2: the Vanguard total market index that's become the largest fund
Speaker 2: in the world. What goes into managing a fund of
Speaker 2: that size and that importance to Vanguard.
Speaker 3: I mean, it really starts, It really starts with the people,
Speaker 3: you know, just making sure that we have humble, really
Speaker 3: talented professionals who you know are truly dedicated to managing
Speaker 3: these uh these index funds on a day to day basis.
Speaker 3: And you know, the way the way we think about
Speaker 3: it are our pms also service traders, and so they're
Speaker 3: working very closely day by day making sure that Total
Speaker 3: Stock Market Index fund and all of our other equity
Speaker 3: index funds are you know, minimizing the tracking here, also
Speaker 3: trying to make sure that we're minimizing transaction costs as
Speaker 3: we're transacting in the marketplace, also being cognizant of the
Speaker 3: tax implications of trading activity, and then also looking to
Speaker 3: add value at the margin through opportunistic ideas and you know,
Speaker 3: through rebalancing corporate actions, new issues and things that nature
Speaker 3: to try to eat into the expense ratio at the margin,
Speaker 3: but again in a highly highly riskcontrolled way. And the
Speaker 3: great thing is we have, you know a team of
Speaker 3: folks who have been doing this for decades, and you know,
Speaker 3: they're unmatched in the industry because they're dedicated to doing indexing.
Speaker 3: A lot of firms you find folks who start with
Speaker 3: indexing and move on to something else. At Vanguard, this
Speaker 3: is a career destination for a lot of these folks
Speaker 3: and they love every minute of what they do.
Speaker 2: So a lot of indexers will track somebody else's index.
Speaker 2: The Vanguard Total Market Index is something that Vanguard itself creates.
Speaker 2: There's a separate index group and there's a whole bunch
Speaker 2: of technical ways that's set up. What goes into making
Speaker 2: changes in stock memberships tell us a little bit about
Speaker 2: what that process is like.
Speaker 3: So so for total stock market, the Total Stock Market
Speaker 3: Index fund that is a CRIPS fund that is you know,
Speaker 3: run by the University Chicago. They create the benchmark. We
Speaker 3: help them in terms of identifying and creating the parameters
Speaker 3: around how.
Speaker 1: That that that index should be constructed.
Speaker 3: The biggest things are you know, primarily when there's corporate actions,
Speaker 3: there's there's I pos. Those are the things that typically
Speaker 3: drive changes because again this represents the total market. So
Speaker 3: you have small cap, small cap, MidCap, large cap, you
Speaker 3: have growth value and blend in there. So the turnover
Speaker 3: is primarily driven by corporate actions and I pos and
Speaker 3: then you know, the team spends a lot of time
Speaker 3: just making sure they handle those you know, really really
Speaker 3: well to minimize costs, make sure that tracking are remains
Speaker 3: relatively tight, and the other thing the team does. And
Speaker 3: we have a securities lending team that that also spends
Speaker 3: a lot of time making sure that we're getting value
Speaker 3: for the securities that are in demand, and that that
Speaker 3: those earnings from the securities lending revenue, net of the
Speaker 3: cost to run that group, goes right back to the fund.
Speaker 3: So our shareholders benefit whenever there's a lot of demand
Speaker 3: for certain securities that we own. So that's a that's
Speaker 3: another contributing factor to performance in those funds as well.
Speaker 2: That's a performance enhancer that ultimately leads to the ability
Speaker 2: to lower costs to that fund.
Speaker 3: Well, it lowers the ultimate drag that you would have
Speaker 3: from transaction costs exactly.
Speaker 1: Yeah.
Speaker 2: So so how often does Vanguard create a new index?
Speaker 2: So what's that process?
Speaker 1: Like, we tend not to create the index. You know,
Speaker 1: that's an outsourced process.
Speaker 3: So you know it's really function of you know, do
Speaker 3: we have gaps in our lineup, and so you know,
Speaker 3: we get we get input from, you know, the various
Speaker 3: business divisions, whether or not it's our retail group or
Speaker 3: institutional group, our financial advisor services group. You know, are
Speaker 3: there gaps where we feel like, hey, we don't have
Speaker 3: a relevant offering that's that's needed by our clients. And
Speaker 3: then we find out we do research. The portfolio review
Speaker 3: department does the research to figure out who would be
Speaker 3: the best and most well equipped you know, index provider
Speaker 3: for that type of mandate, and then our team works
Speaker 3: very closely with them in terms of the due diligence
Speaker 3: process and making sure that that index is constructed in
Speaker 3: a way that we're comfortable and the right levels of
Speaker 3: controls are in place. And then you know, once that's
Speaker 3: set up, the team is ready to go to start
Speaker 3: managing against that newly defined index.
Speaker 2: And when you say there are gaps in your lineup,
Speaker 2: you're not talking about trendy things like hey we don't
Speaker 2: have a metaverse index. Oh look, we don't have an
Speaker 2: AI index. It's always much broader and more permanent if
Speaker 2: that's the right word, or long lasting on.
Speaker 3: That yeah, yeah, you know, again, these need to have enduring,
Speaker 3: long term investment merit. That's one of the key defining
Speaker 3: principles before we launch a fund, is it is there
Speaker 3: real value long term for this type of investment strategy.
Speaker 3: And you're absolutely right, Vanguard is not the type of
Speaker 3: firm that, you know, we'll launch thematic products that you
Speaker 3: know are focused on when not it's AI water whatever,
Speaker 3: That's just not what Vanguard does. We're looking for long term, enduring,
Speaker 3: you know, investment solutions and products that will be you know,
Speaker 3: we'll provide our investors with you know, long term opportunity
Speaker 3: that will serve them really well.
Speaker 2: So a couple of years ago I wrote a column
Speaker 2: about this shocking little aspect of Vanguard that I think
Speaker 2: nobody understood, which is the patents that Vanguard had on
Speaker 2: the way you manage taxes for mutual funds, which made
Speaker 2: your mutual funds behave more like atfs and that there
Speaker 2: was no tax pass through typically. It kind of made
Speaker 2: me think of a question. When you're the size of Vanguard,
Speaker 2: how do you balance discipline on the one hand with
Speaker 2: the need for creativity and occasionally thinking out of the box.
Speaker 2: You would think they might be at odds. What's that like?
Speaker 3: Yeah, the main thing very it's a great question. The
Speaker 3: main thing goes back to, like what's the enduring philosophy.
Speaker 3: What are we trying to accomplish for our clients. And
Speaker 3: you know, at the end of the day, they come
Speaker 3: to us to try to get long term exposure to
Speaker 3: a segment of the market, and we want to do
Speaker 3: that in the best possible way, making sure they're getting
Speaker 3: the market return, you know, minus the expense ratio, which
Speaker 3: again we will try to you know offset with security
Speaker 3: lending revenue and you know thoughtful rebalancing strategies. But at
Speaker 3: the end of the day, it's really boils down to
Speaker 3: you know, broad based exposure in a low cost, diversified
Speaker 3: way for our clients, which we think will ultimately serve
Speaker 3: them really well as they're constructing their portfolios.
Speaker 2: Most people think of Vanguard as passive. First, tell us
Speaker 2: a little bit about what the chief investment officer does
Speaker 2: for the passive side of an investment business.
Speaker 3: A big part of it is really around when there's
Speaker 3: more complicated corporate actions that are happening that you know,
Speaker 3: entail a level risk. There's conversations that happen with our
Speaker 3: risk management department to make sure we're comfortable in terms
Speaker 3: of what kind of exposure that that that creates in
Speaker 3: the fund.
Speaker 2: And when you say corporate actions, we're talking about M
Speaker 2: and A, I POS bankruptcies. Anytime somebody outside of your
Speaker 2: decision making process either exits or enters.
Speaker 1: A market, yeah, exactly.
Speaker 3: So when you know when there's major turnover like that
Speaker 3: that happens, you know you always have the option, Hey,
Speaker 3: can you do it exactly on the time that it
Speaker 3: enters the benchmark?
Speaker 1: Do you need to do some of it ahead of time?
Speaker 3: Do you need to do some of it afterwards to
Speaker 3: try to smooth out the process. And you know that's
Speaker 3: a risk decision that you have to make. You know
Speaker 3: how much liquidy is going to be there when there's
Speaker 3: a major activity that happens. Is the pricing more attractive
Speaker 3: right away versus waiting until it starts trading in the
Speaker 3: secondary market. Those are the considerations and the conversations that
Speaker 3: we have with our risk team and our senior investment
Speaker 3: professionals on the equity side.
Speaker 2: So it's pretty well established amongst the academic research that
Speaker 2: passive on the equity side beats active over the long haul,
Speaker 2: but that's not true on the fixed income side. Active
Speaker 2: on the fixed income tends to be passive because the
Speaker 2: choices amongst fixed income are just so much greater than
Speaker 2: what you have in equity. Tell us a little bit
Speaker 2: about what USCIO do on the bond side.
Speaker 3: So on the bond side, we have both, so you know,
Speaker 3: we do bond indexing in a highly diversified way, cutting
Speaker 3: across segments including you know, treasuries and including governments, corporates,
Speaker 3: mortgages and things of that nature, global portfolios that give
Speaker 3: you a tremendous amount of diversification that's headed back to
Speaker 3: the US dollar, which in a highly diversified way is
Speaker 3: a great way to get to get bond exposure. To
Speaker 3: your point, in terms of you know, active fixed income,
Speaker 3: we do have a very large active fixed income team
Speaker 3: where that team has been very successful in terms of
Speaker 3: being able to add value over the long term. And
Speaker 3: so when you look at some of the results, and
Speaker 3: a big chunk of that comes from, you know, our
Speaker 3: credit research capabilities within the team, both investment grade, emerging
Speaker 3: market as well as high yield. But ninety two percent
Speaker 3: of our active bond funds have done better than the
Speaker 3: average fund over their lipper group averages over a five
Speaker 3: year period and eighty seven percent of our active fixed
Speaker 3: income fund of outperform at benchmarks on a three year
Speaker 3: basis against their benchmarks. And then you know, if you
Speaker 3: look at a five year time horizon's seventy seven percent.
Speaker 3: So you know our active team has been successful outperforming
Speaker 3: at benchmarks. And you know, big part of it is
Speaker 3: do you have the credit team that can do to
Speaker 3: due diligence because credit is where we think we can
Speaker 3: add the most value by credit research, and we see
Speaker 3: that on the municipal bond side as well, where we
Speaker 3: have a very active municipal bond franchise, and the credit
Speaker 3: research allows that team to consistently add value relative to
Speaker 3: the benchmarks, providing better, better outcomes for our client's long term.
Speaker 2: It's really quite fascinating. On the equity side, two or
Speaker 2: three percent of the stocks are where all the value
Speaker 2: is created. On the fixed income side, it seems like
Speaker 2: eliminating the worst ten twenty thirty percent of stocks in
Speaker 2: terms of either risk or duration is where all the
Speaker 2: alpha gets generated.
Speaker 3: Yeah, I mean in fixed income because again it tends
Speaker 3: to be a defense into act class. What you want
Speaker 3: to do is you want to try try to avoid
Speaker 3: the losers, right, where you know, what's the what's the
Speaker 3: upside When you invest in the bond, you know, you
Speaker 3: get your money back, You get your money back, you
Speaker 3: get your coup on payments and your principal. You know,
Speaker 3: at maturity on time, the downside is you get zero
Speaker 3: because the company files for bankruptcy and there's no recovery value.
Speaker 3: So you know, again, for defensive asset class, we've always
Speaker 3: thought that you want to limit the amount of risk
Speaker 3: that you take in in what's supposed to be ballanced
Speaker 3: in the portfolio. And you know, the way we're able
Speaker 3: to accomplish that is that, you know, because we are
Speaker 3: we have so much scale and ability, you know, to
Speaker 3: keep costs low. At Vanguard at the end of the day,
Speaker 3: our active fix income managers don't need to take the
Speaker 3: same level of risk as some of our competitors, simply
Speaker 3: because they don't have the same level of headwind. Our
Speaker 3: expense ratios are lower, so when things don't look attractively
Speaker 3: priced in the marketplace, you don't need to sit there
Speaker 3: and try to overcome a heavy expense ratio all the time.
Speaker 3: We can be patient, we can wait, we can wait
Speaker 3: till the market's a bit more attractive. And when we
Speaker 3: feel what we feel, we're being rewarded for risk taking.
Speaker 2: There's a little mold ultiplier effect from the low cost
Speaker 2: side of Vanguard in that you don't have to swing
Speaker 2: at every pitch. The ability to say no, no, we're
Speaker 2: good with this, We'll wait till opportunities look a lot
Speaker 2: more attractive. I don't get that sense from a lot
Speaker 2: of people in finance. They're judged every month, they're judged
Speaker 2: every quarter, and they feel like, what's the old joke,
Speaker 2: never never mistake activity for progress?
Speaker 1: That's right?
Speaker 2: That seems to be really common in Wall Street.
Speaker 1: Yeah.
Speaker 3: I mean for our teams, our active teams, their performance
Speaker 3: is valued on a three year basis, so you know,
Speaker 3: three years, Ye, it's amazing. So when we think about
Speaker 3: how how those teams are evaluated, it's a three year number.
Speaker 1: So how did you perform?
Speaker 3: Because in any given quarter, any given year, you know,
Speaker 3: you could have you know, winners and losers in terms
Speaker 3: of strategies. But what you're trying to do is you're
Speaker 3: trying to string you know, good periods together and over
Speaker 3: three year period, we feel like there's enough opportunities for
Speaker 3: teams if they're good at what they do to add value,
Speaker 3: and that's what we've been able to demonstrate over time.
Speaker 2: It's so fascinating because I would assume that intellectually everybody
Speaker 2: understands that's true, but emotionally two bad quarters and it's like,
Speaker 2: we know, we told you three years, but we're getting
Speaker 2: pressure from investors and we have to make a change,
Speaker 2: Like to stay with that is really challenging.
Speaker 3: Well, you know, it's a great point, Barry, but the
Speaker 3: reality is, like when you're running portfolio is in a
Speaker 3: highly risk controlled way. You're trying to manage the downside, right,
Speaker 3: So when you have three years, you have three years
Speaker 3: again because you're trying to make sure people have an
Speaker 3: opportunity for their strategies to play out over time. But
Speaker 3: you're also making sure that you're contraining the risk that
Speaker 3: even if you do have a bad year, it's not
Speaker 3: going to be it's not going to be so bad
Speaker 3: that investors start running for the hills.
Speaker 1: Again.
Speaker 3: We want investors to stay in each product long term
Speaker 3: because we think they provide good, long term, enduring value
Speaker 3: for our clients.
Speaker 2: And Vanguard famously, during the financial crisis, not only did
Speaker 2: you not see outflows, you actually saw inflows. I got
Speaker 2: to imagine a year like twenty twenty two wasn't horrible
Speaker 2: for Vanguard's asset growth.
Speaker 1: You know, it's interesting.
Speaker 3: I mean, there's certain segments of markets that did quite well,
Speaker 3: certain segments of the business. But you know, you also
Speaker 3: have you also have a period of time when there's
Speaker 3: repricing that happens in the fixed income space, like we
Speaker 3: saw and it was pretty rapid last year, right, and
Speaker 3: you had a.
Speaker 2: Five hundred basis points of rate increases.
Speaker 3: Exactly, that's exactly. And when you saw you know, the
Speaker 3: US AD down thirteen percent last year. For folks who
Speaker 3: again who are investing for retirement and in their five
Speaker 3: twenty nine plans, they're not concerned about it. But when
Speaker 3: you translate that to folks who might have a heavy
Speaker 3: municipal bond portfolio, right, and those folks who are in retirement,
Speaker 3: and you know, they don't like principal losses. They like
Speaker 3: tax free income, but they also don't like principal losses.
Speaker 3: So when you have a big backup like that, you
Speaker 3: tend to see outflows in that segment of the market
Speaker 3: more than you would see in the taxable market, which
Speaker 3: tends to be in our case more long term retirement
Speaker 3: orient in things of that nature. So you will see
Speaker 3: some pressure on unis in those types of interest rate environments.
Speaker 2: Huh. Really interesting. So let's talk a little bit about
Speaker 2: last year, where all I heard was the sixty portfolio
Speaker 2: is dead.
Speaker 3: Discuss it's interesting. I mean, we've heard that over and
Speaker 3: over again. You know, it was a tough year for
Speaker 3: investors in terms of both stocks and bonds being down,
Speaker 3: where stocks were down about twenty percent, the USAG was
Speaker 3: down thirteen percent.
Speaker 2: When was the last time we saw stocks and bonds down?
Speaker 2: Double jigg It's like eighty one something like.
Speaker 1: That somewhere in that type of horizon. Yeah, exactly.
Speaker 3: So it's not something that many investors have been accustomed
Speaker 3: to or have seen in their lifetimes. But the reality is,
Speaker 3: the reality is when you think about the components in
Speaker 3: the terms of long term investing, the bond portion of
Speaker 3: the of the equation provides that balance in diversification. Now, again,
Speaker 3: in any one given year, you will have a sixty,
Speaker 3: You can have a sixty forty portfolio that underperforms and
Speaker 3: both sides of the equation go down. But for a
Speaker 3: long term investor who's saving for retirement, that balance and
Speaker 3: diversification has has proved and developed delivered really good long
Speaker 3: term returns. So when you go back to nineteen twenty six,
Speaker 3: if you were an investor since then, sixty forty portfolio
Speaker 3: has returned eight point eight.
Speaker 1: Percent on average over that time horizon, which is impressive.
Speaker 3: Yeah, because you know, again it provides you diversification and
Speaker 3: reduces some of the volatility. But there will be periods
Speaker 3: of time where again that type of portfolio when you know,
Speaker 3: we were an environment where interest rates were held down
Speaker 3: to historically low levels, so you know, when they repriced,
Speaker 3: it's not surprising that you see losses on the bond
Speaker 3: side of the equation. But if you go back to
Speaker 3: the period before twenty twenty two, from twenty nineteen to
Speaker 3: twenty twenty one, a sixty forty portfolio actually produced fourteen
Speaker 3: percent returns over that time horizon, which is above the
Speaker 3: long term average. So you know, in a grand scheme
Speaker 3: of things, it's not surprising that there's periods of outperformance
Speaker 3: and that ultimately will lead to periods of underperformance.
Speaker 2: That's right, and I'm glad you mentioned the period before that.
Speaker 2: Go to the decade before twenty twenty two. The equity
Speaker 2: side was something like thirteen percent, and then whatever you
Speaker 2: got from bonds was just a bonus. That's exactly the
Speaker 2: top of that. People forget that when they see a
Speaker 2: single year like twenty twenty two, and they really forget
Speaker 2: that in a year like twenty twenty three where everything
Speaker 2: is going up, I mean other than gold, what hasn't
Speaker 2: been going up this year? How do you deal with
Speaker 2: the opposite of last year with the first half like
Speaker 2: this year.
Speaker 3: Well, look, you know, clearly the equity market has been
Speaker 3: on a tremendous tear so far this year, up eighteen
Speaker 3: eighteen nineteen percent year to date. But the key thing
Speaker 3: there is, like again, investors have to keep in mind
Speaker 3: that that's probably not sustainable long term. And so again
Speaker 3: the importance of having a diversified portfolio is critically important.
Speaker 3: And just think about, you know, fixed income and money
Speaker 3: markets as an asset class. You know, for a decade
Speaker 3: you weren't earning anything in a money market fund because
Speaker 3: interest rates by the Federal Reserve were pegged to zero
Speaker 3: and you have to take on significant duration risk and
Speaker 3: credit risk just to earn a couple percentage points. And
Speaker 3: now you know you're in an environment where money market
Speaker 3: funds are yielding five and a quarter percent. You have,
Speaker 3: you know, the US AG that's yielding somewhere close to
Speaker 3: five percent, so four and a half five percent, And
Speaker 3: so in a grand scheme of things, investors are actually
Speaker 3: being rewarded for having exposure.
Speaker 1: To money markets and bond funds.
Speaker 3: And so, you know, if people are truly concerned about
Speaker 3: a sixty forty portfolio, they should be concerned about it
Speaker 3: for ten years. Now's not the time when you're back
Speaker 3: to an environment where you're actually getting a real yield
Speaker 3: when it comes to the bond market.
Speaker 2: I'm glad you brought up money markets because it's this
Speaker 2: overlooked area that when you have rates at ultra low levels,
Speaker 2: it kind of gets forgotten about. But is it fair
Speaker 2: to say that this year and perhaps last year you
Speaker 2: saw a big shift of client cash assets into money markets.
Speaker 3: We definitely saw we definitely saw a number of clients
Speaker 3: who started embracing money markets. And the reality is for
Speaker 3: a lot of investors, it truly is free money. Right,
Speaker 3: So when you think about what people are earning in
Speaker 3: their deposit accounts at their banks, and banks have historically
Speaker 3: been very slow, today very slow in terms of raising
Speaker 3: deposit rates because those deposits tend to be very sticky.
Speaker 3: And I've had people stop me, even at Vanguard in
Speaker 3: the hall way and say, wow, I didn't realize that
Speaker 3: I've been leaving this much money on the table by
Speaker 3: keeping you know, a sizeable amount of deposits at my bank.
Speaker 1: Yeah, I've moved it to a money market.
Speaker 3: Now I'm getting a you know, five and a quarter
Speaker 3: percent type yield, which is amazing when some folks are
Speaker 3: still getting you know, less than half a percent in
Speaker 3: many cases at the in the in the bank.
Speaker 2: So it's shocking that this has gone on. How much
Speaker 2: inertia there is in finance that even if you're just
Speaker 2: getting your December bonus that you're going to pay Uncle
Speaker 2: Sam in April, leaving that money in a savings account
Speaker 2: for a third of the year, you're leaving a chunk
Speaker 2: of change.
Speaker 1: Free money. It's free money. It's free money.
Speaker 2: Quite interesting. So at what point do you think high
Speaker 2: yields become a headwind for stocks or is it just
Speaker 2: overall part of the sixty forty portfolio? And hey, we'll
Speaker 2: either taken on the equity have for the bond half.
Speaker 2: We don't care.
Speaker 3: Well, you know, I think if you look at if
Speaker 3: you look at what our return expectations are for the
Speaker 3: global balance portfolio, we're expecting that over the next decade
Speaker 3: or so, somewhere in the neighborhood of about you know,
Speaker 3: five and a half percent for a global balance portfolio,
Speaker 3: so combination of equities, bonds, US and international stocks. And
Speaker 3: the reality is, you know, our return expectations for the
Speaker 3: US equity market is a bit more muted. You know,
Speaker 3: we're expecting US equity market returns to help our somewhere
Speaker 3: around five percent or so were international equities because of valuations,
Speaker 3: probably seven to seven and a half perc.
Speaker 2: So let's talk about that because that gap invaluation has
Speaker 2: persisted for a long time. Certainly for a few years
Speaker 2: after the financial crisis, it seemed like US stocks were pricey,
Speaker 2: forward return expectations were low, and the opposite was true overseas,
Speaker 2: but the US seemed to be the only place to be.
Speaker 2: How durable is that shift, given how large that gap
Speaker 2: has gotten in valuation between US stocks and the rest
Speaker 2: of the developed world.
Speaker 3: Yeah, I mean, if you were to take a look
Speaker 3: at what's happened over the last last ten years, looking
Speaker 3: at the s and P five hundred index versus you know,
Speaker 3: like the Footz Global Allcap XUS there was a seven
Speaker 3: percentage point difference per year by being seven seven hundred
Speaker 3: basis points of outperformance by the US market relative to
Speaker 3: the international markets. But you know, so if you were
Speaker 3: to take a look at where PE ratios are today
Speaker 3: between the S and P, which has an earning yield
Speaker 3: of about five percent, and you look at the Footz
Speaker 3: Global Allcap x US, it has an earning yield of
Speaker 3: eight point three percent, right, and so not in substantial
Speaker 3: there's a substantial difference. Now, there are sector differences, so
Speaker 3: you know, and we could talk about that to some
Speaker 3: degree as well, but the reality, even if you adjust
Speaker 3: for sector differences, there's still a big gap. There's still
Speaker 3: a big gap in terms of the PE ratios across
Speaker 3: the US market relative to the rest of the world.
Speaker 3: And so unless we expect earnings for US companies to
Speaker 3: vastly outpace what's happening in the international markets, and it might,
Speaker 3: but there's a lot of great news already priced into
Speaker 3: the marketplace. And when you think about translating S and
Speaker 3: P five hundred PE to a you know, an implied
Speaker 3: equity risk premium. By looking at the ten year treasury yield,
Speaker 3: you know, you're two hundred basis points below what it's
Speaker 3: been for the last ten years.
Speaker 2: So let's let's do a little comparison. Because I'm always
Speaker 2: skeptical when we're people focus on a single metric like
Speaker 2: price to earnings. I want to make that more three dimensional.
Speaker 2: So if Europe is at an eight point three earning
Speaker 2: shield and we're about a five percent, what's the growth
Speaker 2: rate difference between the two? Meaning are people willing to
Speaker 2: give up a little bit of earnings in order to
Speaker 2: accept a faster growth rate that certainly we've seen on
Speaker 2: the tech side. I can't speak across every sector.
Speaker 3: Well, I think there's a couple of things. There's a
Speaker 3: couple of things that are very I mean, one of
Speaker 3: it is, you know, you know, do you expect the
Speaker 3: earnings growth to live up to the expectations that are
Speaker 3: already priced into the US market. And if so, that's
Speaker 3: fine for where we are, but that's not necessarily going
Speaker 3: to lead to multiple multiple expansion, right, And a big
Speaker 3: driver of the outperformance over the last decade of US
Speaker 3: stocks for relative the international evaluation expansion. So that's all sentiment
Speaker 3: that's exactly it, and a lot of we would say,
Speaker 3: a lot of that's probably already baked into the marketplace
Speaker 3: and is run its course. Could it go further, of
Speaker 3: course it could, but at some point there is a
Speaker 3: tipping point where people start saying, well, in the US,
Speaker 3: I have alternatives. I have alternatives because I can go
Speaker 3: out and buy a money market fund at five and
Speaker 3: a quarter percent and I don't have to take a
Speaker 3: lot of risk. And you know, if if again based
Speaker 3: on our forecast for US equity markets, they're somewhat muted
Speaker 3: because valuations are stretched in our view relative to our
Speaker 3: fair value model. And so I think a lot of
Speaker 3: investors have alternatives. They can buy money markets, they can
Speaker 3: buy bond funds, where there was no alternative ten you know,
Speaker 3: for the last ten years, because we didn't get any
Speaker 3: real yield when it came to the fixed income or
Speaker 3: a money market space. But there's really alternatives today for
Speaker 3: investors either in fixed income money markets.
Speaker 1: Are international stocks? Right?
Speaker 2: The twenty ten's were certainly the Tina decade. It's funny
Speaker 2: you mentioned multiple expansion. When you look at the eighty
Speaker 2: two to two thousand bull market, something like seventy five
Speaker 2: percent of those gains came not from earnings growth, but
Speaker 2: from a multiple expansion. I'm curious if that's kind of
Speaker 2: repeating now and the twenty twenty pandemic fiscal stimulus, which
Speaker 2: was massive under two presidents, What does that do in
Speaker 2: terms of resetting the cycle? And can we stay pricey
Speaker 2: forget higher for longer? Can we stay pricey for longer
Speaker 2: given all the stimulus that's coursing through the system.
Speaker 3: Well, I think there's a couple of things. One, it
Speaker 3: becomes a factor. Yeah, you know, the economy can clearly
Speaker 3: keep rowing along, which we've seen, you know, the fiscal
Speaker 3: stimulus that we've seen. You know, you know there's over
Speaker 3: two trillion dollars that was saved. You know, our reports
Speaker 3: show and some of the data out in the marketplace
Speaker 3: shows that about a trillion dollars of that has already
Speaker 3: been spent down. So we you know, investors and savers
Speaker 3: are definitely eating into that that that safety net, which
Speaker 3: over time is that continues to decline, should slow the
Speaker 3: economy down to some degree.
Speaker 1: So I think that's going to be a big factor.
Speaker 3: But then you know, when you think about you know,
Speaker 3: the broader equity markets, again, the biggest thing that would
Speaker 3: be concerning if you start seeing a continued rise in
Speaker 3: interest rates and that has to put pressure on equity valuations.
Speaker 3: I mean, equities are a ultra long duration asset, and
Speaker 3: if you're discounting those future cash flows at higher interest rates,
Speaker 3: that means you get a lower present value and at
Speaker 3: some point that will bite. Who knows when that's going
Speaker 3: to be. Nobody knows when when you could see that
Speaker 3: kind of that kind of return to normal, but you
Speaker 3: know you would you would definitely expect that higher interest
Speaker 3: rates will put continued pressure on the equity market and
Speaker 3: get valuations back to something that's more more normalized over time,
Speaker 3: because you do expect if you're investing in equities, to
Speaker 3: earn equity risk premium, and the fact that it's so
Speaker 3: much lower than what we've seen historically, it starts to
Speaker 3: beg the question how much exposure. If I'm a shorter
Speaker 3: term investor, how much exposure do I want in that space?
Speaker 3: For long term investors, it doesn't matter.
Speaker 2: So let's let's stay with interest rates for a moment.
Speaker 2: Interest rates are much higher than they've been over the
Speaker 2: past decade, But let's look at the past fifty or
Speaker 2: seventy five years. Interest rates today are clearly above where
Speaker 2: they were, but they're not especially high by historical standards.
Speaker 2: I think a lot of people confuse those two.
Speaker 3: Yeah, I think I think a lot of investors end
Speaker 3: up succumbing to recency biases. Right, So, the fact that
Speaker 3: we've been in an environment where interesting zero anymore, that's
Speaker 3: exactly so people think that that's the end. I think
Speaker 3: what you have to look at, and our team has
Speaker 3: done work on this, you have to look at what
Speaker 3: do you think is the appropriate level for FED funds
Speaker 3: in the neutral state where it's not stimulative or you know,
Speaker 3: or you know, contracting the marketplace. And so some of
Speaker 3: the research our team has done it says that, look,
Speaker 3: you know, long term FED funds could be higher than
Speaker 3: what the market is pricing in the market, and the
Speaker 3: Fed have said, you know, probably when they put our stars,
Speaker 3: you know, fifty basis points or half a percent. You
Speaker 3: have two percent inflation on top of that, that gives
Speaker 3: you a long term FED funds at two and a
Speaker 3: half percent, right. You know, our Investment Strategy group, through
Speaker 3: their analysis, they estimate that our star is probably closer.
Speaker 1: One and a half percent.
Speaker 3: So that brings you to a longer term FED funds
Speaker 3: target of closer to three and a half if they're
Speaker 3: successful at bringing rates back down to two inflation back
Speaker 3: down to two, I should say, and then if you
Speaker 3: build a normal you know, term structure on top of
Speaker 3: that between you know, three month treasury bills and ten
Speaker 3: year bonds of about one hundred basis points, you know,
Speaker 3: and that brings you to a ten year that's probably
Speaker 3: fair around four and a half percent. And so, but
Speaker 3: it all depends on you know, what happens from a
Speaker 3: you know, an inflation perspective, economic growth perspective, and how
Speaker 3: aggressive the Fed will have to be, you know, going
Speaker 3: down and going down the path here.
Speaker 1: But again we think.
Speaker 3: That you know, there is some risks that you know,
Speaker 3: rach will have to go a bit higher here, you know,
Speaker 3: just giving everything that's going on in the economy, in
Speaker 3: the marketplace.
Speaker 2: And the ten year is not all that far away
Speaker 2: from four and a half. It's not that that's something
Speaker 2: that end of year is not unthinkable, that's right, Huh.
Speaker 2: Really interesting, So everybody seems kind of shocked by what's
Speaker 2: taking place in twenty twenty three, although to be fair,
Speaker 2: everybody seemed shocked at what took place in twenty twenty two.
Speaker 2: What are your thoughts about how Wall Street plays this
Speaker 2: forecasting game where everybody's thrown a dart, someone randomly gets
Speaker 2: it right, But it just seems like it's a weird
Speaker 2: game to be playing with people's serious money.
Speaker 3: Yeah, we try not to be in the short term
Speaker 3: forecasting game. And you know, forecasting is really hard, and
Speaker 3: it's even harder to the extent you're doing it for
Speaker 3: the short term. And so you know, when we think
Speaker 3: about the vang Or Capital Markets model, which drives a
Speaker 3: lot of our advice engines and the recommendations that we
Speaker 3: provide the client, the truly not point forecast in the
Speaker 3: narrow sense of how people tend to do forecast. It's
Speaker 3: really the median results of a large simulation that shows
Speaker 3: a probabilistic you know, determination of results, and it runs
Speaker 3: a scale and then meetiing is basically that midpoint of
Speaker 3: all those observations, and so you know, we have a
Speaker 3: distribution around that, and so again, you know there's gonna
Speaker 3: be periods of time when you're in the tail, both
Speaker 3: positively and negatively. But again, what we try to say
Speaker 3: to our clients, you have no control about how volatile
Speaker 3: the market it's going to be. What you can control
Speaker 3: at the end of the day is how diversified you are,
Speaker 3: how cognizant you are to the cost that you're paying
Speaker 3: for the funds that you're investing in, and doing that
Speaker 3: in a highly diversified, low cost way, we think is
Speaker 3: going to provide investors the best chance for their investment
Speaker 3: success long term, versus focusing on you know, daily news announcements,
Speaker 3: what's happening. Those are the types of things that create
Speaker 3: trading activity but don't tend to add value for long
Speaker 3: term investors.
Speaker 2: So you recently came out and criticized some of the
Speaker 2: market timing that's been going on. What I found shocking
Speaker 2: about that was we really have to warn people about
Speaker 2: the dangers of market timing and overtrading to hasn't that
Speaker 2: isn't had an issue that the academics have long ago resolved.
Speaker 1: Yeah, but it is.
Speaker 3: It is very I mean, the data will show that
Speaker 3: it is not fruitful. It is not helpful to long
Speaker 3: term investors to engage in that type activity. But we
Speaker 3: don't have to look too far past with the meme
Speaker 3: stocks and things of that nature, where you know, a
Speaker 3: variety of reasons. Things pop on the headline and there's
Speaker 3: a lot of momentum, and folks get involved, and you know,
Speaker 3: people get caught up and believe it's you know, it's
Speaker 3: easy money and it's free money, and the reality is
Speaker 3: that's speculation and not investing. And so, you know, speculating
Speaker 3: is you know, that's a very risky strategy, and you know,
Speaker 3: when we think about investing, that's not the way you
Speaker 3: construct an investment portfolio. If you want to do that
Speaker 3: from a speculative, speculative standpoint, that's fine, do that with
Speaker 3: a very small portion of your portfolio, but the majority
Speaker 3: of it should be investing in long term strategies that
Speaker 3: will add value and are enduring.
Speaker 2: My favorite part of TikTok were the TikTok speculative traders. Hey,
Speaker 2: investing is easy just by stocks that are going up
Speaker 2: and when they stop going up, you sell them. And
Speaker 2: what could be an easier way to support your lifestyle?
Speaker 2: And as that was happening in real time during twenty twenty,
Speaker 2: I'm sure you felt the same thing. I felt like,
Speaker 2: I've seen this movie. I know exactly how this is
Speaker 2: going to end.
Speaker 3: That's exactly right, very I mean, I've been in this
Speaker 3: industry long enough. I started my career in finance in
Speaker 3: nineteen ninety eight and very familiar with the dot com
Speaker 3: era and what happened there, and it was very very
Speaker 3: reminiscent of that period of time where you know, during
Speaker 3: that period, anything with a dot com behind it, you know,
Speaker 3: ran to the moon and you couldn't go wrong. Well,
Speaker 3: that works until it doesn't, and then one day you
Speaker 3: realize that these companies actually they have to be real
Speaker 3: companies that make money, produce earnings, and our viable businesses.
Speaker 3: And you know, in a speculative fever, people lose sight
Speaker 3: that you know, having cash flow, having earnings matters in
Speaker 3: the long run. And you know, sometimes people have to
Speaker 3: learn a hard, hard lesson that again, that's not investing
Speaker 3: and that's really speculative. And you know it's a lesson
Speaker 3: to learn early on in your career. Huh, when you
Speaker 3: don't have a lot of money, versus later on in
Speaker 3: your career where you start to accumulate some massets, you
Speaker 3: definitely want to be more of an investor versus the speculator.
Speaker 2: Right making mistakes early. You know, there's a chapter in
Speaker 2: I want to say it's Adam Smith's The Money Game
Speaker 2: from the nineteen sixties where he talks about a fund
Speaker 2: manager running a bunch of you know, young run and
Speaker 2: gun managers. Why do you have these young kids working
Speaker 2: for you? Oh, because they'll buy all this stuff that
Speaker 2: I won't buy, and we'll make money in it, and
Speaker 2: when it blows up, I'll sell early and fire them
Speaker 2: all and go on to the next group. I was
Speaker 2: reminded of that last time, but it seems shocking. I guess,
Speaker 2: like the market timing argument, we're still in a debate
Speaker 2: between me stock pickers and indexers. It's fascinating that every
Speaker 2: new generation has to learn the hard lessons over and
Speaker 2: over again.
Speaker 1: I mean, you just have to look at history.
Speaker 3: But you know, some people have to learn the hard way,
Speaker 3: using real money to do that. But eventually most people
Speaker 3: find religion and start thinking about, Hey, how do I
Speaker 3: actually construct a portfolio that's durable that will provide the
Speaker 3: type of economic return that's required to you know, meet
Speaker 3: their retirement needs, college saving needs, or you know, buying
Speaker 3: that new house or whatever the case may be.
Speaker 2: So let's talk about some adult decision making around a
Speaker 2: durable portfolio. Internally, we've been having discussions about extending duration.
Speaker 2: If you tightened up duration in twenty one or even
Speaker 2: twenty two, you did better than the index. At what
Speaker 2: point do you say, hey, I'm not getting paid to
Speaker 2: take risk short term because of the possibility of those
Speaker 2: rates dropping. Whether it's twenty four or twenty five, where
Speaker 2: do you start thinking about going back out on the
Speaker 2: duration curve for fixed income?
Speaker 3: I think you have to get to a place where
Speaker 3: you feel like the FED is done and inflation is
Speaker 3: starting to be you know, you can you're convinced that
Speaker 3: inflation is under control and path towards you know, the
Speaker 3: Fed's two percent target. So we think there's still some
Speaker 3: ways for that to go. And again, you know, if
Speaker 3: you if you go back to what I was saying
Speaker 3: earlier about our star and the neutral FED funds, Right,
Speaker 3: if we believe that's three and a half percent with
Speaker 3: a normal shape y old curve at four and a half,
Speaker 3: we're not far from that, but it's also that's far
Speaker 3: from neutral. Right if we think four and a half
Speaker 3: percent is fair value, like, we're not at fair value yet,
Speaker 3: so that means it also means that, hey, it's not cheap,
Speaker 3: so you don't want to dive in with both feet.
Speaker 3: You know, when you're approaching a fair value, want things
Speaker 3: to actually be cheap before you do that. So you know,
Speaker 3: the risk is that, you know, rates back up more,
Speaker 3: and so I think you still want to be somewhat
Speaker 3: conservative when it comes to duration positioning in a portfolio.
Speaker 2: So I always have a question about that two percent
Speaker 2: UH inflation target. It not to be flippant, but it
Speaker 2: seems like a made up number. I hunted for some
Speaker 2: academic research that said here's why, and I came up
Speaker 2: with something. The former FED Vice chair I wrote a
Speaker 2: paper that said, oh, it's a thing from New Zealand
Speaker 2: in nineteen eighties. It's kind of a made up round number,
Speaker 2: and everybody adopted it. Can it be that simple? We're
Speaker 2: using a FED inflation target that's just a made up number.
Speaker 3: Well, that's that's what the that's what the market is
Speaker 3: gravitating towards. That is what the FED is operating off of.
Speaker 3: And until they decide to communicate a different message, that's
Speaker 3: what the market is going to continue to follow. Right,
Speaker 3: And you know their behavior says that, hey, they want
Speaker 3: to see inflation coming down.
Speaker 1: It's also difficult.
Speaker 3: It's also difficult to be you know, changing, you know,
Speaker 3: changing the strategy when you're falling behind your current strategy.
Speaker 3: Because if you say, hey, I'm going from a two
Speaker 3: percent target to three percent, well you're at three percent
Speaker 3: because you couldn't hit two percent. Well it is three
Speaker 3: percent the right number, and so well.
Speaker 2: If you're going to make up a number, make up
Speaker 2: one you can reach as opposed to one you can.
Speaker 3: But we have to we have to be realistic too,
Speaker 3: right Berry. I mean, the reality is, for ten years,
Speaker 3: we couldn't hit two percent inflation. We were on the
Speaker 3: other side, downside, yea, right, we were underneath that two percent.
Speaker 3: They were working really hard to try to get to
Speaker 3: two percent, and they couldn't achieve it.
Speaker 2: So, in an era of low monetary policy and almost
Speaker 2: non existent fiscal stimulus, upside target of two percent doesn't
Speaker 2: seem to make a lot of sense. Fast forward to
Speaker 2: the twenty twenties. Now we're in an era of massive
Speaker 2: fiscal stimulus, not nearly as much monetary stimulus. Does it
Speaker 2: make sense to have the same target when you're coming
Speaker 2: from five percent above it as opposed to zero percent
Speaker 2: under it.
Speaker 3: Well, the thing is it's supposed to be a long
Speaker 3: term target, and it's supposed to be an average target over time.
Speaker 3: So you know, I haven't heard anything that would say
Speaker 3: that they're in the process of deciding to switch it
Speaker 3: to a higher number. I think that's something to be debated.
Speaker 3: Once you get back to close to your target and
Speaker 3: that gives you greater credibility over time, which you don't
Speaker 3: want to do, is you don't want to change. You
Speaker 3: don't want to change the you know, the the mile
Speaker 3: post while you know the cars, the car still in
Speaker 3: motion and you're running the race. You want to basically say, hey,
Speaker 3: we're anchored to this, we believe in this, and ultimately
Speaker 3: we think this is going to allow us to pursue
Speaker 3: a level of economic growth that continues to give us
Speaker 3: full employment, you know, moderate price increases. Again, it's debatable
Speaker 3: when not two percent is the right number three percent.
Speaker 3: All I would say is that it took us a
Speaker 3: long time to get north of two percent.
Speaker 1: We finally got to.
Speaker 2: Six trillion dollars in physical stimulus. But that raises the question, Hey,
Speaker 2: you know, when it gets icy out, you got to
Speaker 2: slow down.
Speaker 1: You do have to slow down.
Speaker 3: But the reality is, like that stimulus is starting to
Speaker 3: wear off, Like those savings are starting to be consumed.
Speaker 3: You're starting to see you're starting to see the Fed
Speaker 3: reduce its balance sheet slowly, but it's starting to happen.
Speaker 3: And you've seen you've seen the Federal Reserve clearly, you know,
Speaker 3: raise interest rates dramatically five hundred and twenty five basis
Speaker 3: points in fifteen months. That they're they're definitely trying to
Speaker 3: slow the economy down, and so you know, we'll have
Speaker 3: to wait and see if that's enough. But again, we
Speaker 3: have to remember and we can't be blindsided by the
Speaker 3: fact that, you know, inflation has been well above their
Speaker 3: target because of all this stimulus. But this stimulus was
Speaker 3: slowly ebbing out of the system and we're gradually going
Speaker 3: back to We're going in the right direction. The question
Speaker 3: is how long will it take for us to get there?
Speaker 2: Huh? Really interesting. I'm going to throw you a curveball
Speaker 2: question which I did not disclose in advance, as I
Speaker 2: wanted to surprise you. You're born in Germany, raised in
Speaker 2: a military family, and you speak fluent German with your
Speaker 2: mom and English with your dad. Tell us a little
Speaker 2: bit about your experience growing up overseas as a military brat.
Speaker 3: It was a phenomenal, phenomenal experience. I mean, I had
Speaker 3: the privilege of growing up in a bilingual household, and
Speaker 3: my maternal grandmother was also home and she spoke primarily
Speaker 3: primarily German to me. So what was challenging for me
Speaker 3: was like, actually, when we moved to the US when
Speaker 3: I was seven years old, I was always good with math,
Speaker 3: but my English, my English.
Speaker 1: Was below average.
Speaker 3: And what I my wife is an English She taught
Speaker 3: English at the college level. She said, you, you dummy,
Speaker 3: English was a second language for you, because and it
Speaker 3: really was. I didn't know it, even though you know,
Speaker 3: I went to a US Department of Defense school in Germany.
Speaker 3: But my primary language I was spoken by my grandmother
Speaker 3: who I spent most of my time with, was German.
Speaker 2: Huh.
Speaker 1: So you know that.
Speaker 3: Was that was interesting. And I loved the experience of
Speaker 3: living over in Germany. And I had the benefit as
Speaker 3: a kid, you know, during my teenage years going back
Speaker 3: to visit family members and friends over the years going
Speaker 3: back to Germany, which is also a very rewarding and
Speaker 3: memorable part of my childhood.
Speaker 2: Huh. Really interesting. So I only have you for a
Speaker 2: few more minutes. Let's jump to our favorite questions that
Speaker 2: we ask all of our guests that are a little
Speaker 2: bit revealing of who they are. Tell us a little
Speaker 2: bit about what you've been streaming. What's been keeping you
Speaker 2: entertained these days?
Speaker 3: So from a streaming standpoint, there was a series went
Speaker 3: through the first season that ended. They're going to start
Speaker 3: a new one in twenty twenty four. It's called Night Agent, Yeah,
Speaker 3: which was really interesting. There was an FBI agent who
Speaker 3: was manning a telephone in the basement of the White House, right.
Speaker 1: Yeah.
Speaker 3: It was actually a really good series, and the good
Speaker 3: news is it got picked up and I think they're
Speaker 3: coming out with new episodes in twenty twenty four.
Speaker 1: But it was a really, really interesting.
Speaker 2: He kind of gets the crappiat out of him in
Speaker 2: the first episode.
Speaker 1: I saw that.
Speaker 3: It was very fun. It was a really interesting So
Speaker 3: that's one. And then because of my kids also been
Speaker 3: you know, big fans of All American and bel Air,
Speaker 3: which are also really cool series that we've been watching.
Speaker 3: So those were a couple.
Speaker 2: Tell us a little bit about your early mentors who
Speaker 2: helped to shape your career.
Speaker 3: I had a number and I'll go back to the
Speaker 3: first two I had when I started in this industry.
Speaker 3: Darryl Thomas was leading investment grade capital market the City Bank.
Speaker 3: He actually helped me, helped me get my internship. I
Speaker 3: met him at a career fair. He helped me get
Speaker 3: my first internship on Wall Street with somebody I kept
Speaker 3: in contact with over the years and he helped me,
Speaker 3: you know him. And there was another individual, carmin Or Cilio,
Speaker 3: who also worked at City at the time. Those two
Speaker 3: individuals gave me a lot of perspective when I was
Speaker 3: thinking about moving from Wall Street to the by side,
Speaker 3: and thanks to some of the words of wisdom from Carmine,
Speaker 3: you know. He said to me when I was thinking
Speaker 3: about making a change, he said, if you could.
Speaker 1: If you could join.
Speaker 3: A well regarded, well respected asset manager, you're going to
Speaker 3: have a much longer and more fruitful career than if
Speaker 3: you stay on the cell side. And that was advice
Speaker 3: he gave me back in nineteen and ninety nine.
Speaker 2: Good good advice and good time.
Speaker 3: I send Carmine chats every once in you know, every
Speaker 3: once in a few years, saying thank you for the advice,
Speaker 3: and I appreciated it really interesting. And then along the
Speaker 3: way Ken Volpert, who hired me huge Huge Mentor. He
Speaker 3: hired me to trade treasuries and mortgages on the team
Speaker 3: Big Mentor Advocate sponsored friend, and of course Tim Buckley
Speaker 3: who put me, who gave me the opportunity to go
Speaker 3: to Australia and then ultimately the Fixed Income Group and
Speaker 3: then put me in the seat that I'm in today.
Speaker 3: I've only had two bosses at Vanguard in twenty four
Speaker 3: years and they've both been phenomenal.
Speaker 2: Wow, really really interesting. Let's talk about books. What are
Speaker 2: some of your favorites and what are you reading right now?
Speaker 1: Right now, I'm reading Plunder by Brendan Below.
Speaker 3: It talks about the private equity, the private equity world.
Speaker 3: I have a daughter who wants to do private equity investing,
Speaker 3: so I'm doing some some due diligence and the book
Speaker 3: is actually an interesting read, but it talks a bit
Speaker 3: about the dark side of private equity with it versus
Speaker 3: some of the favorable things that come out of that
Speaker 3: space as well. And then there was another book that
Speaker 3: I read, you know previously, that I thought was really interesting.
Speaker 3: It's non market related, but it talks a lot about
Speaker 3: history in the US. It's called From Here to Equality
Speaker 3: by William Darty. And Kirsten Mullen, and it really examines
Speaker 3: a lot of American history that isn't covered in in
Speaker 3: in school. You know, it's a deep look at some
Speaker 3: of the you know, really pivotal points in the nation's
Speaker 3: history that you know, where we had a number of
Speaker 3: opportunities to create a more equal in just society, where
Speaker 3: we chose to go left instead of right, and you know,
Speaker 3: we're still dealing with some of those ramifications in today's
Speaker 3: modern age. So I thought it was a really really
Speaker 3: interesting book about American history.
Speaker 2: Huh, really interesting. What sort of advice would you give
Speaker 2: a recent college grad who was interested in a career
Speaker 2: in either asset management or finance.
Speaker 1: I would say a couple of things. One is, be
Speaker 1: a continual learner. Master your craft.
Speaker 3: So spend the time and energy and the effort to
Speaker 3: learn and become an expert. And you know, the key
Speaker 3: thing is, you know, continuous learning, and there's opportunities to
Speaker 3: learn from everybody that you interact from and interact with.
Speaker 3: And so the other thing I would say is, you know,
Speaker 3: for young people, you have to remember a career as
Speaker 3: a marathon and not a sprint. The problem that people
Speaker 3: face is that they're constantly comparing themselves with somebody else
Speaker 3: who started at the same time, or one of their
Speaker 3: peers who is working at a different firm. And what
Speaker 3: I always say to the younger joiners to our firm
Speaker 3: is run your own race. Judge your success by how
Speaker 3: you're doing. Are you getting better than where you were
Speaker 3: a year before, are you continuing to learn?
Speaker 1: Are you being developed?
Speaker 3: And if you focus on yourself about getting better every day,
Speaker 3: you're going to have a much more fruitful and long
Speaker 3: living career than somebody who's constantly comparing themselves to somebody else.
Speaker 2: Huh. Really good advice. And our final question, what do
Speaker 2: you know about the world of investing today? You wish
Speaker 2: you knew thirty or so years ago when you were
Speaker 2: really first getting started.
Speaker 3: I would say, the power of compounding is such a
Speaker 3: beautiful thing. I just thought wish i'd learn that lesson
Speaker 3: earlier on. And you know what we were speaking about before,
Speaker 3: the idea of investing versus speculating as a youngster. You know,
Speaker 3: it's always it's always interesting to you know, you think
Speaker 3: about an industry or a company and you're like, oh,
Speaker 3: it'd be a great investment, But what you what you're
Speaker 3: doing is speculating, and you should be investing and let
Speaker 3: that investment compound over thirty forty fifty years, and you
Speaker 3: can see that even small amounts of money will grow
Speaker 3: into a rather large sum if you do it on
Speaker 3: a consistent basis. So I wish I'll learn those lessons
Speaker 3: earlier and early in my lifetime.
Speaker 2: Huh, really great stuff. We have been speaking with Greg Davis.
Speaker 2: He is the chief investment officer at the Vanguard Group.
Speaker 2: If you enjoy this conversation, please check out any of
Speaker 2: the five hundred previous interviews we've done over the past
Speaker 2: eight years. You can find those at iTunes, Spotify, YouTube,
Speaker 2: wherever you find your favorite podcasts. Sign up for my
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Speaker 2: I would be remiss if I did not thank the
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Speaker 2: Paris Wald is my producer, Attika Valbrun is my project manager.
Speaker 2: Justin Milner is my audio engineer. Joan Russo is my researcher.
Speaker 2: I'm Barry Ridholts. Been listening to Masters in Business on
Speaker 2: Bloomberg Radio