The value of time-varying portfolios

Transcript

Roger Aliaga-Díaz: As global head of portfolio construction for Vanguard, I think frequently about investors’ long-term success.

At Vanguard, we believe investors should first align portfolios with goals and then “stay the course.” But staying the course can mean different things for different portfolios. Some investors may benefit from strategic shifts in their mix of stocks and bonds, based on changing market and economic conditions.

Such a “time-varying asset allocation” isn’t for everyone, though. It requires comfort with a degree of active risk, specifically model risk, an investor’s willingness to put their faith in our disciplined approach to navigating changing market and economic environments.

Time-varying asset allocation is not market-timing. Asset managers that employ such a tactical approach claim to have superior information, allowing them to outperform everyone else. We don’t make such a claim. We assess public information such as market valuations, or market regimes such as low-yield environments, periods of rising rates, or persistently high inflation.

Our edge is in comparison with static portfolios. Using a systematic process, we adapt asset allocations to changing market conditions that otherwise might put goals at risk and out of reach.

• Most tactical approaches make short-term bets based on discretionary market calls. Vanguard’s time-varying methodology is model-based, systematic, and repeatable.
• Our methodology, using Vanguard Capital Markets Model^® 10-year forecasts, is based on modest predictability of asset returns over the medium term, in contrast to the short-term nature of most tactical approaches.
• Our framework carefully discounts model forecast risk by assessing returns through a holistic, distributional approach, not through precise point forecasts.

A candidate for time-varying asset allocation would seek to maintain a target portfolio return or a level of portfolio income over a certain period like five to 10 years. Over such a period, we would expect market factors such as equity valuations and interest rates, or economic forces such as inflation and monetary policy, to cause returns to deviate from historical averages.

In those cases, if the market environment evolves unfavorably, portfolio adjustments may keep goals on track. Our capital markets model evaluates dozens of variables and informs our Vanguard Asset Allocation Model, which systematically builds portfolios with those explicit inputs.

Over a long term, we would expect economic environments and market conditions to eventually revert back to normal and asset returns to converge to their historical patterns, making the more traditional static portfolio approaches more appropriate.

We do recommend that investors leverage professional financial advice in relation to time-varying portfolios. This webpage provides our views on time-varying portfolios in the current context of today’s economic and market conditions.