Vanguard LifeStrategy defends ‘home bias’ to UK shares

Sam Benstead interviews Vanguard’s LifeStrategy product manager Mohneet Dhir.

Dhir breaks down the five LifeStrategy options, ranging from 20% in equities to 100% in equities, and explains who the typical investor is for each fund.

She speaks about how they invest, including the role that stocks and bonds play in a portfolio, and why the range is comfortable with its “home bias” to UK shares.

Vanguard LifeStrategy 80%, 60% Equity and 20% Equity are on ii’s Super 60 list of recommended funds.

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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Mohneet Dhir, product manager of Vanguard’s LifeStrategy range. Mohneet, thanks very much for coming into the studio.

Mohneet Dhir, product manager of Vanguard’s LifeStrategy range: Happy to be here, Sam.

Sam Benstead: There are five LifeStrategy funds ranging from 20% in equities to 100% in equities. So, who are the typical investors in each of these strategies?

Mohneet Dhir: It really depends on people’s goals and alignment to those goals when they’re choosing the right investment for them. As an example, for someone like my parents, who are in their late 60s, I would say something like Vanguard LifeStrategy 20% Equity or Vanguard LifeStrategy 40% Equity, depending on personal risk appetite, would be the right choice.

Someone like my son, who’s four and a half years old, would be on the higher equity scale. So, something like a Vanguard LifeStrategy 100% Equity. And for someone like me, I would sit somewhere in the middle, maybe a Vanguard LifeStrategy 60% Equity or an Vanguard LifeStrategy 80% Equity, so it really depends.

However, it’s not just age-dependent, there are other factors people might take into consideration, whether it’s a goal of buying a house, or funding university education, where you have five years or 10 years to save. Depending on the time horizon, you can choose what your risk appetite is and what level of equity exposure and bond exposure are right for you.

Sam Benstead: So, generally speaking, if you’re looking to grow your portfolio more, you’d have more in equities, if you’re looking for a bit more defence in your investments, you’d have more in bonds, fixed income. But why is this? What are the characteristics of each of these asset classes which lead to a defensive portfolio or a more growth-oriented portfolio?

Mohneet Dhir: Bonds generally are seen as safe assets, or safer assets, compared to equities. And that’s obviously high-quality bonds, right? Investment-grade bonds. So, LifeStrategy invests only in high-quality investment grade bonds, which are extremely liquid.

So, if you were looking to redeem from your portfolio at short notice, it’s quite quick and easy to do compared to if you were invested in more risky parts of the market. What that also means is that it makes the portfolio quite defensive. So, usually bonds are quite negatively correlated to equities.

What that means is that when equities go down, bonds will protect your portfolio in terms of having a positive return. To offset some of that negative return you get from equities.

In a normal market environment, you generally do tend to get less volatility as well if you’re in a fixed-income heavy portfolio, especially if you’ve invested [the] majority in government bonds, as LifeStrategy is, while also having exposure to high-quality credit or corporate bonds as well. So, that’s essentially your fixed-income portion of the portfolio.

When you look on the equity side, so if you’re going up the scale and you go into LifeStrategy 80% Equity or LifeStrategy 100% Equity, because you have more equity exposure, investors will be able to see that equity markets tend to be more volatile.Stock prices are more subject to human emotions given how stock markets trade, which means that stocks can be extremely volatile on a day-to-day basis. There’s a lot of participants in the market, you've got day traders, you’ve got hedge funds, you’ve got all sorts of participants that are driving the share price. So, in the short term, equities can be a lot more volatile.

However, if you’re an extremely young person who has a long time horizon, or you have a personal goal which has a 10 or 15-year time horizon, generally your risk appetite would be higher than someone who's got a two or three-year goal that they’re trying to reach financially.

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Sam Benstead: And you have this very rigid stock/bond split. How do you maintain that, why is it so rigid, and how often are you rebalancing to keep that?

Mohneet Dhir: We try and rebalance as frequently as we can. We’re very mindful of costs, as you know. So, rebalancing comes into the equation there as well. We want to make sure that when we rebalance, we rebalance in a cost-efficient way.

Now, thanks to our investors and all the support that we’ve been given from everyone who’s invested in LifeStrategy, we’ve been lucky enough to have positive net cash flows for the majority of the time that LifeStrategy has been running since inception. What that means is that we can use cash flows to rebalance, which keeps the costs extremely low compared to having to sell existing positions, which really helps. It’s frequent and it’s very cost efficient, which passes more return back to investors.

Now, in terms of the stock/bond split, the reason that we’re so rigid about it is because clients may be using that in different ways. So, a client who’s invested in LifeStrategy 40% Equity, for example, could be using LifeStrategy 40% Equity as a core [holding in] their investment portfolio, which means that you need your core to be stable, predictable, and to know what’s in there.

However, if we kept moving the goalposts, going from LifeStrategy 40% Equity to LifeStrategy 50% or 45% Equity, it wouldn’t quite have the same effect for that investor because it would either put the risk up or down for their entire portfolio, depending on what else they’re invested in and what other assets they have exposure to.

Sam Benstead: As you alluded to there, it’s often a core allocation for investors. Some people might just own one fund, a LifeStrategy fund. They just allocate for stocks and bonds. There are other asset classes as well. There’s real estate, there’s private equity, there’s commodities like gold. So, why do you avoid those, and why do you just stick to stocks and bonds in this range?

Mohneet Dhir: I don’t think it’s as clear-cut as people think it is when it comes to investing in other asset classes. For us, if we were to introduce any other asset class into LifeStrategy, it would be a question of risk/return.

So, with any asset class coming into LifeStrategy, if the potential risk that you’re introducing is higher than the additional potential return you get, then it doesn't make much sense for us to want to do that.

If anything, it wouldn’t be fair on investors because we’re introducing more risk into that portfolio without giving them additional return.

Now, the other element to think about is something like real estate. Through global equity markets, investors already have real-estate exposure. They even have exposure to commodities, it may not be directly through commodity futures or something, but you do have exposure through companies that are operating within that arena in global equity markets or in the global bond markets. So, you are getting exposure to those asset classes indirectly, but just not in the way that people are more familiar with.

Sam Benstead: In the LifeStrategy 100% Equity fund, about 25% of the equities are UK equities. This compares to between 3% and 4% for a global developed market world tracker at the moment. So, you have this “home bias”, you’re overweight the UK. Why is this, and is this a conscious decision to be overweight in the UK?

Mohneet Dhir: The home bias is really a result of client preference. We’ve done a lot of research as well from a wider perspective as to why people prefer to have a home bias. What effect does it have on your portfolios over the long term? How do people apply a home bias? There’s a lot of independent authorities that do a lot of research on this as well.

What’s quite clear to see is that not just in the UK, but in the US, Australia and many other economies, people do have a preference for investing in companies that they know of. So, someone in the UK, for example, would be much more familiar with Tesco (LSE:TSCO) than with Walmart Inc (NYSE:WMT), for example, right? It’s a name that they know and it’s a name that they understand. So, they might be more comfortable investing in Tesco than Walmart.

Now, the problem is if you’re fully focused in your home country, which is if you only have exposure to the UK, you don't get that diversification. So, what we’re trying to do with LifeStrategy and through the home bias is find that sweet spot or find that balance, if you will, where investors get that diversification through being invested in global markets, but still have an element of home bias, that sort of familiarity and preference that they have shown to us since the inception of LifeStrategy.

Now, obviously, having said that, we do a review on home bias every year, it’s an annual review. So, every year we do a pulse-check on [whether] that preference has changed. How has it changed? Has it gone up? Has it gone down? And as a result of that, we then reflect that in LifeStrategy. But obviously over the last sort of 10 years or so, we haven't really seen much of a change in that preference.

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Sam Benstead: So, that’s likely to stay at around a quarter of the 100% Equity fund. You haven’t changed your view on the UK despite the underperformance relative to the US over the past decade?

Mohneet Dhir: If you look at the performance on the bonds and equity side, obviously the last few years have been difficult from a performance perspective. However, the UK has performed well in the last year or so, the last two years, in fact, I would say.

Part of that has been recovering from the previous few years. When we talk about the US, US equities are the target for a potential valuation correction as the market is expecting. In a situation like that, having this exposure through LifeStrategy will help investors.

It’s really difficult to know which asset class or part of the market is going to be the big outperformer in the next five, 10, 20 years. It’s really difficult to predict that. Some of the best fund managers can't do it on a consistent basis, which is why having that global diversification, despite the home bias, [means] you are still exposed to a lot of other markets and stocks and bonds, which gives you that diversification [and means you are] not having to make those decisions and rely on the wisdom of the broader market.

Sam Benstead: When people think about doing a core allocation to equities, LifeStrategy 100% Equity is often in the conversation. So is a global market-cap weighted tracker fund with maybe just 1,500 companies, with the big US tech stocks at the top and a few UK companies near to the bottom. What are the advantages of choosing the LifeStrategy fund approach to just a simple market-cap weighted index tracker?

Mohneet Dhir: There’s different pros and cons for both sides. For LifeStrategy, the way that we think about it is that we use different building blocks to get the equity exposure that we do have through Life Strategy 100% Equity. What that obviously provides investors with, which they wouldn't get in the one product that they're buying, is product diversification.

And you’re not exposed to, potentially, the Magnificent Seven taking over your entire portfolio, as some investors will be exposed to. So, building that equity exposure through different building blocks does [mean we are] able to introduce more product diversification into a client’s portfolio, which they won't necessarily get otherwise.

Sam Benstead: The fees for the range are 0.22%. It’s competitive, but there are cheaper options out there for investors. And that’s been the fee since launch, I think, more than 10 years ago. So, will that stay at that level, or are there plans to actually reduce the fee given the assets that you've generated?

Mohneet Dhir: We’ve actually cut the fees more than three times since launch. That was a result of the funds growing and us finding more scalability in the processes that we used to run LifeStrategy funds. And obviously the funds are growing, which is great. The funds growing more essentially means that it gives us more room to be able to cut fees.

The LifeStrategy funds, along with pretty much all Vanguard products, go through a rigorous value assessment when it comes to pricing, and we’re continuously looking at making it more efficient and finding ways to try and cut costs. And, as most investors will know, Vanguard’s been a leader in that space for so long. The “Vanguard effect”, as everyone likes to call it, is coming into the market, and lowering prices for everything.

And we do hope that in the future we can cut the costs for LifeStrategy at some point. But we need to be able to get to a sustainable level of assets where we can find more scalability in order to be able to cut those costs. Because for us, that direction, it’s only a one-way direction. Our aim is never to increase costs. Our aim is always to cut costs and we want to be in a position to be able to do that for LifeStrategy as the funds grow in a scalable way.

Sam Benstead: And finally, the question we ask all our guests. Do you personally invest in your funds?

Mohneet Dhir: I do, and my family does as well. I’m in LifeStrategy 80% Equity and my son is in LifeStrategy 100% Equity.

Sam Benstead: Mohneet, thanks very much for coming into the studio.

Mohneet Dhir: Thank you so much.

Sam Benstead: And that’s all we've got time for today. You can check out more Insider Interviews on our YouTube channel where you can, like, comment and subscribe. See you next time.