Vanguard LifeStrategy: the outlook for the next decade

Three of the five funds in the Vanguard LifeStrategy range – 20%, 60% and 80% - form part of interactive investor’s Quick-start Funds ideas for beginner investors. The trio are also members of interactive investor’s Super 60 funds.

Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to the latest in our Insider interview video series. Today, I'm joined by Mohneet Dhir, who is a product specialist on the Vanguard LifeStrategy Fund range. Mohneet, thanks for joining me today.

Mohneet Dhir, product specialist on the Vanguard LifeStrategy fund range: Thank you, it's lovely to be here.

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Kyle Caldwell: Vanguard's Life Strategy range launched over two decades ago, and each of those five funds in the range, they have outperformed comparable funds in their Investment Association (IA) sector. Does this show that index investing is the best route to success for investors that are after diversification?

Mohneet Dhir: We are incredibly proud that the Vanguard Life Strategy range has been able to serve investors well over the last 10 years. We think a big part of that has been the simplicity of the funds and the transparency they offer in terms of the asset allocation and the underlying building blocks that the funds invest in.

As you can see, the funds are incredibly diverse, so you're not putting all your eggs in one basket, which is going to be more and more important going forwards as we enter a market which is going to be extremely uncertain, recovering post-Covid, with high inflation, the highest inflation we've seen for a while, [and] extremely low yields on bonds. So it's going to be even more important to be incredibly diversified. And while LifeStrategy funds have been great performers, beating index and active funds within their Morningstar peer group,  we still think that there is a place for active funds.

It really comes down to the goals of the investor. For example, an investor, depending on their risk appetite, could choose either an active fund or an index fund, depending on what their time horizon is, depending on what they're investing for. There are many factors they need to consider when it comes to where to invest. We are also one of the largest active fund managers in the world, and people often forget that. So we are not against active investing. We think there's definitely a place for it, but we think it's important for investors to know what they're investing in, whether that's index or active, and for there to be transparency in what they are investing in and [for them to] really understand what's under the bonnet of their investments.

It really comes down to the four key investment principles that Vanguard LifeStrategy funds were based on when they were launched, and that's starting with a clear goal for your investments: why are you investing in the first place and what are you looking to achieve from it? Making sure that there's a balance within your investments, whether that's through equities and bonds, or just making sure that you have enough diversification. But then also just being really mindful about costs because it eats into your returns. I think for all these reasons, the funds have performed well over the 10 years and have been a great investment for many.

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Kyle Caldwell: And is that place for active funds, then, potentially as a satellite holding rather than a core holding?

Mohneet Dhir: It could be either to be honest, it depends. Again, it depends on the goal of the investor. And some of our investors actually use a LifeStrategy fund, for example, as a core holding, and then they'll complement it with another active proposition or an active product, such as a global credit fund, for example. I think, again, it comes down to those four key investment principles. If your investment goals demand that you use LifeStrategy as a core holding, [you can] then potentially have an active fund, which gives you a bit more risk that you [might] want because it's in line with your investment goals. It doesn't have to be one way or the other, you can definitely mix [funds in the range] with active funds.

Kyle Caldwell: In the years to come, do you expect the fund range to be as successful as it has been over the past decade, particularly when the expectation is that returns are likely to be lower than investors have been used to?

Mohneet Dhir: Yes, so we're going into an extremely difficult time for markets, for investors, for everyone, really, whether that's investing [or in people's lives], given where inflation is. We really hope that the LifeStrategy funds can provide investors with the same sort of return sustainability and returns that we've provided over the last 10 years. In fact, we're positive that they will. Given that the asset allocation is strategic, so we don't make market calls, we are not trying to time the market, which is becoming more and more difficult to do, given how much uncertainty and moving factors there are.

Central banks are becoming more unpredictable as well in the way that they do things. So we're hoping that the strategic asset allocation will play its part in the future as well as it has done over the last 10 years. Being strategic allows you to really hold your positions and ride through market turbulence and market storms, especially if you have the right balance in your portfolio.

If we take, for example, the 60% equity fund, it's almost a perfect balance where you have 60% equity and 40% bond exposure, which acts as a buffer when there's equity volatility. So that's the kind of thing you need to think about when you're investing for the next 10 years because the returns are going to be lower, t hat's just the reality. We've been living among central banks, providing a lot of stimulus in the market, and that's changing and we just need to come to terms with the reality that return expectations for the next 10 years are lower than the last 10 years. But that's OK.

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Kyle Caldwell: There's been a number of commentators and plenty of articles saying that the 60/40 portfolio model (60% in shares, 40% in bonds) is outdated and will become particularly challenged in an environment of higher inflation. What are your thoughts on that? Particularly given that the Vanguard LifeStrategy 60% Equity fund invests in that manner.

Mohneet Dhir: The Life Strategy 60% Equity fund is actually one of the largest within the range. We feel proud that investors have faith in us through that product. We think that going forwards, the role of bonds and that 60/40 mix, the equity bond mix, is going to be even more important than it has been in recent history, whether that's the last 10 years or the last 30 years. And the reason for that is that the next 10, 20 years are going to be different from what we've seen in the last 10 to 20 years, especially in the next 10 years, we're likely to see more uncertainty.

Since the global financial recession, we've had a record amount of stimulus from central banks, and that's changing now. And what that means is more uncertainty in the market. But the world is also recovering post-Covid. We've also got the highest geopolitical tensions we've had in a long time. All these factors combined indicate the need for bonds being even higher going forward than they have been in the past. And especially in a multi-asset portfolio.

The role of bonds is extremely important going forwards because we always ask investors to think about bonds as the defensive element in their multi-asset portfolios because their role is to make sure they can buffer off the volatility that equities bring into multi-asset portfolios. Equities are extremely important as return generators, but you also need bonds to be able to make sure that the [volatility] and heat doesn't impact your overall return.

And additionally, it's extremely important for that bond allocation in a 60/40 portfolio to be diversified, not just across the maturity spectrum, but also across the credit spectrum. So not to be only invested in triple As or double As, but to also have triple Bs. It just provides investors with a varied good source of return rather than putting all their eggs in one basket. 

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Kyle Caldwell: As well as having high inflation levels to contend with, investors are also having to think about interest rates, which are on the rise. How concerned at all are you regarding interest rates in relation to bond duration?

Mohneet Dhir: Duration essentially is a measure of interest rate risk that comes with a particular bond. And you're correct that interest rates are going to be higher going forward. As we've heard from central banks and the guidance that they've given, that doesn't mean that they should be concerned about investing in bonds. Are the returns going to be different from what we've seen in the last 10 years? Yes, because yields are going to be higher. That's just the nature of the market as it is right now.

However, when investors are thinking about duration risk or bond risk in general, it's important to always come back to the point of diversification. Often in an environment where central banks are raising rates, investors tend to sort of flock to US shorter duration bonds, which essentially means investing in shorter maturity bonds. Now, that's essentially putting all your eggs in one basket. You're exposing yourself to a market event, to a market risk, and to a higher risk than you probably signed up for. When I talk about diversification, that can be across different maturities. So in Life Strategy funds, for example, we invest in bonds from a maturity of two years up to a maturity of 30 years. And there's various maturities along the way. And what that really does is spread your risk across different maturities across the yield curve.

Now, if we think about the yield curve, which is essentially bonds of different maturities going all the way up to longest maturity and how much they provide in terms of yield. So, as investors going into longer maturity bonds, you should get compensated for higher yield because you're taking more risk over a longer period of time. Now, what's interesting when you think about the yield curve is that different bonds perform differently in different environments. If you look at the yield curve, it doesn't always react in the same way [during] different market events or market turbulence.

It's worth keeping that in mind, because when you enter markets that are uncertain, where you are not 100% sure as to what the result of central banks increasing rates is going to be, [it's important to think about how] it is going to impact bond markets. And when you have moving factors such as inflation, and potentially the highest geopolitical risk we've had for a long time, then the environment we are going into going forwards is very different from what we've seen in the last even 30 years, I would say.

So it's important for investors to keep all that in mind when they're thinking about duration risk. It's not just about how high the duration is. In fact, if you look at global bonds, the global bond index has a duration of over nine years. But in the first quarter of this year, which was extremely disruptive and volatile for investors due to Russia's invasion of Ukraine, it's so interesting to see that global bonds were actually one of the best performers in terms of risk-adjusted returns.

What that means is, the returns that they provided, adjusted for the volatility that they introduce in the portfolio, was actually one of the highest among equities, different bonds, among commodities and gold as well. So that's something for investors to consider. Bonds often get a bad name, but they are actually one of the best risk-adjusted investments an investor can have.

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Kyle Caldwell: And has Vanguard considered, or is it considering now, adding alternative assets such as property and infrastructure in order to give some additional diversification, as well as having equities and bonds?

Mohneet Dhir: When we introduced the Life Strategy funds, the research we did prior to that showed that the equity-bond mix actually works really well over different market cycles without the need to add alternatives such as property, commodities, etc. We are continuously looking at this and our research team, the investment strategy group that works in Vanguard, is responsible for looking at different market dynamics, behaviours, correlations, etc.

Our research doesn't show at this point in time that we need to add anything else to LifeStrategy. We still think that the equity bond/mix works, but as I said, we continuously review it. So if that changes at some point in the future, if correlations change quite dramatically within the market, [and] the dynamics of different asset classes change, then it could be something that we do further research into.

Kyle Caldwell: Now the final question, which we ask everyone we interview, do you personally invest in any of the five funds in the range?

Mohneet Dhir: I do indeed. I invest in the Vanguard LifeStrategy 80% Equity fund. I'm investing mostly to help my son and to hopefully renovate a house sometime in the future. I feel that 80% [fund] is a good mix for me given my time horizon, and the 20% bond allocation helps buffer any equity volatility. However, for my son, who is two years old, I recently opened a Junior Isa and he is invested in Vanguard LifeStrategy 100% Equity because he's got a long time to go before he's going to need that money.

Kyle Caldwell: Mohneet, thank you for your time today.

Mohneet Dhir: Happy to be here. Thank you for inviting me.

Kyle Caldwell: That's all we have time for, for today. You can check out the rest of our Insider Interview video series on the interactive investor YouTube channel where you can like and subscribe. Look forward to seeing you next time.