As you study the markets, what two or three things will Vanguard especially focus on in the year ahead?Mr. Buckley: In the United States, we’ll be watching the effects of “dovish” or slow tightening as the Federal Reserve finally moved off its near-zero interest rates. With such low rates, we’ve seen some distorted behavior in which companies seem more interested in buying back their own shares than investing in their businesses. We have also seen clients take far more risk than they have historically in reach of return. Globally, all eyes will be on China. As its economy continues to slow down, can it brake that deceleration and achieve a high-6% growth rate?
China is a tale of two worlds. It’s dealing with overcapacity in its industrial sector and a high level of debt in the economy. Yet it also has a fast-growing consumer sector and a vibrant service economy. So the question is, will it be able to hand the baton from the old industries to the service sector?
Mr. McNabb: I would just add that when it comes to the Fed raising short-term rates, I think getting back to a more normal rate structure and environment in the long run will be a good thing. Obviously, over the short term, we’ll be watching for any potential disruptions. On China, the only thing I would add is that as the world’s second-largest economy, it represents about 15% of world GDP. But that figure actually understates the country’s impact, because so many other economies have become, in part, dependent on what China buys. So, obviously, we’re paying close attention there.
Vanguard just published its economic and investment outlook for 2016. How can investors best use this analysis?Mr. McNabb: This will be the third year in a row where our outlook is a bit guarded for the next decade. We think returns over that time are likely to be lower than long-term historical norms. For several reasons, stock and bond returns will probably be muted. That means investors would be wise to expect returns from a balanced portfolio of stocks and bonds to be two to three percentage points below what they may have experienced in the past. So for investors to reach their goals, savings rates will become even more important—especially for people getting ready for retirement.
Mr. Buckley: Because we expect lower global growth and lower returns, we hope people won’t be tempted by new investment fads to try to get extra return. I think it’s important to remember that investing is not alchemy. You can’t create extra return without increasing risk. If an investment sounds as if it’s going to provide higher returns, there are probably risks involved that you may not fully appreciate. As Bill said, if you save more, you’ll be better off.
Mr. McNabb: Company directors are always told they should act in the best interest of their shareholders. If I’m a board member, I should be asking, “Which shareholder?” Is it the investor who’s renting the stock for three months? Or the investor who’s in it for the long haul? You can make a case for both. They’re both owners, and they have equal votes. But because Vanguard represents the long-term investor, we want the companies we’re invested in to recognize it’s important to focus on the interests of long-term investors. Vanguard’s actively managed funds tend to be long-term holders of securities, and of course our index funds are essentially permanent stockholders. So we want companies to run themselves with a long-term perspective. The activities of short-term investors make the headlines, but what we’re really concerned about is long-term wealth creation.
Vanguard made news in 2015 when it publicly urged companies to strengthen engagement with their shareholders. What do we hope to accomplish for clients with our corporate governance activities?
Do more companies recognize the importance of the long-term investor than five or ten years ago?Mr. McNabb: At a high level, I would say yes, we’re making progress. The engagement between companies and longer-term investors is greater than it was, and I think we are having good dialogue. We have a team that does much more than just vote proxies. We analyze and discuss many substantive issues with companies, and we’ve had terrific results from personal meetings with directors and senior management. We held more than 700 meetings last year with companies on governance issues.
Vanguard introduced new funds and services in 2015. Which stand out as having potentially the greatest impact on investors?Mr. McNabb: We introduced a number of new funds and made a few changes to existing funds, but I think one thing in particular is worth pointing out. We’re very gratified by our clients’ acceptance of our Personal Advisor Services. It’s grown more quickly than we expected. We have more than 32,000 clients, with about $30 billion in assets, now enrolled. For clients with multiple goals and somewhat complicated situations, the service provides great advice through a dedicated financial advisor at a very low cost.
Mr. Buckley: The one fund change I would highlight is the inclusion of China A-shares in Vanguard Emerging Markets Stock Index Fund. China’s stock market can be expected to be volatile, like other emerging markets. But the fund now gives investors direct exposure to the most influential emerging market in the world.
Do either of you have any particular investment resolution for the year ahead?Mr. Buckley: In our job, it’s easy to start thinking you know more than the market, and it’s always tempting to try to time the market because you live it each and every day. So my resolution is the same every year: Stick to my long-term plan.
Mr. McNabb: I agree, and my goal is similar. I’m going to remain global in my asset allocation. Even though non-U.S. markets have generally underperformed the last several years, I believe in global diversification.
For people who want to be invested beyond the United States, what is a good amount to invest?Mr. Buckley: Every investor’s situation is unique, but if you’re looking for a general guideline, we think it’s reasonable to consider investing about 40% of stock assets in markets outside the United States, and for bonds, around 30%.
As more investors around the world become Vanguard clients, what challenges do you face in managing growth?Mr. McNabb: It’s helpful to remember that growth for its own sake is never our objective. We actually don’t have growth objectives within the company. We spend much less time talking about market share and so forth than most people would imagine, given the success we’ve had. Our basic mission is to make sure that existing clients have high-performing funds at the lowest possible cost. Then we can couple that with great service. We think if we do that, growth will take care of itself. And when we do experience significant growth, we always ask ourselves, “Does it benefit the existing client in terms of creating more scale, which allows us to create more capabilities at lower price?” If the answer is no, then we won’t allow the growth to go too far.
Mr. Buckley: Our duty is always to our existing clients, so any growth has to benefit them. By design we have pushed our expense ratios lower, and we have expanded services through the years. Of course, we have also made sure we have the best possible professionals managing our clients’ money and have delivered excellent long-term performance. Achieving success on these three fronts isn’t easy at any size, but it is our sole focus.
As Vanguard grows, is it harder to maintain the client-centric culture we’re so well known for?Mr. McNabb: I’ll be celebrating my 30th anniversary at Vanguard this year. And it’s really gratifying to see that even as we’ve expanded over the decades, our core values haven’t changed. Since I arrived, we’ve grown from under 1,000 crew members [employees] to nearly 15,000 worldwide. Obviously, I’m biased, but it still feels like a small company with the same values we had 30 years ago. We still have that incredible missionary zeal to take our way of investing to more and more investors because we think it really is the right way.
So as much time as we spend studying the markets and developing our economic outlook, we spend just as much if not more time on our human capital. And that’s been true as we expand our international presence. Bottom line, whether we’re talking about our U.S. sites or our offices abroad, we want to be sure we’ve got great team members and are doing all we can to make Vanguard a great place to work, as well as a great place to invest.
Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.
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