Risk in an Era of Confidence:
Whenever I find something written by John Bogle, the grizzled veteran of 50 years in the business and founder of The Vangard Group, I pay attention. His speech to the New England Pension Consultants' Client Conference in Boston on April 6th 2000 was sensational.
Along with many other most interesting comments*, about half of John Bogle's speech embraced the three principal approaches to risk and controlling risk: 1. ignore equity risk - stay the course with correctly set asset allocation and a long-term horizon 2. reduce risk by broadening diversification among sectors of the equity market 3. reduce risk by reducing equity exposure
1. “If the equity exposure of the portfolio is deemed appropriate to the client's time horizon and need for income (dividend yields and interest coupons, not capital gains) there are far worse strategies than simply staying the course”.
2. “The second approach to risk control”, Bogle says, “is broadening the conventional focus of an equity portfolio in marketable U.S. equities to encompass other equities that have reliably different correlation with the U.S. market, dominated by large-cap growth and value stocks.” After considering alternative investments including foreign stocks, gold*, new enterprises, real estate and hedge funds for some three pages, Bogle says, “I urge you to consider the wisdom of reducing short-term volatility risk by assuming the substantially higher financial risk in owning alternative investments in the portfolio.”
3. John Bogle concludes “that the single most effective way to control risk is by controlling equity exposure.” [W]e must“, he says, “base our asset allocations not on the probabilities of choosing the right allocation, but on the consequences of choosing the wrong allocation.”. Bonds, Bogle says, “diversified portfolios of U.S. Treasuries and corporates rated A or better with little credit risk-are, finally, the investor's only real protection against the most dire consequences of the inevitable uncertainty of equity ownership.” “No one knows whether or not bonds will provide higher total returns than stocks over the next decade or quarter century. But we do know that bonds will produce far higher income. I don't mean to be a Luddite, but income remains important…” With the yield on an all-market stock portfolio now only about 1%, it would be decades, even with substantial dividend growth, before the cumulative dividend payments generated would equal the interest provided by the bond.
More quotations from Bogle's speech of April 6, 2000 * “I may be the first serious investor in decades to bring up the subject of gold as a useful portfolio diversifier, but surely it fills the bill.”
“stocks are facing outsized risks today, and the recent surge of market volatility may be the harbinger, that after all these years, risk is again coming home to roost.” “So let me be clear: you can place me firmly in the camp of those who are deeply concerned that the stock market is all too likely to be riding for a painful fall - indeed a fall that might well have begun.” IT HAD! Bogle was right. Sept 2008 comment.
