Bogleheads is the name of an online investment community that adopted the moniker to honor Vanguard Founder John C. Bogle. The community boasts more than 50,000 members around the world who share investing ideas, help novice investors develop prudent portfolios, and discuss mutual funds, predominantly index funds and ETFs. (However, discussions on the group’s bulletin board, which averages 1,200 posts per day, can wander to such topics as cars, books, and rotisserie chicken.)
The Bogleheads are serious and smart enthusiasts who are vocal advocates of the Vanguard way of investing: Have a plan and stick to it, be balanced and diversified, minimize the impact of costs and taxes, and invest regularly at a healthy clip. Members of the community have published two books (The Bogleheads’ Guide to Investing and The Bogleheads’ Guide to Retirement Planning), maintain a presence on Facebook and Twitter, and meet regularly on a local and national basis.
In fact, the Bogleheads just recently held their 15th annual conference outside of Philadelphia, replete with a variety of group discussions, presentations by Bogle and former Vanguard Chief Investment Officer Gus Sauter, and a visit to Vanguard’s Malvern headquarters. During the visit, more than 200 Bogleheads met with Vanguard crew members, financial professionals, and portfolio managers, and enjoyed panel discussions and an open question-and-answer session with Vanguard investment experts.
Unfortunately, the sheer number of questions exceeded the time allotted to answer them. I sifted through the questions and chose three to answer here:
Is anyone concerned about liquidity with respect to Vanguard’s muni bond funds? What happens with a sudden rise in rates and/or a credit crisis?
I brought in Chris Alwine, head of Municipals & Credit Research in the Vanguard Fixed Income Group, to help answer this one. At the highest level, he noted that Vanguard devotes significant resources to the analysis of liquidity and the development of portfolio strategies to position our taxable and tax-free bond funds to handle the potential for large outflows during periods of extreme market stress. (Note that most Vanguard fund holders are buy-and-hold, long-term investors, so large outflows have historically not been an issue.)
While bond market liquidity is difficult to measure, Vanguard defines liquidity as the ability to sell large amounts of securities quickly with very little impact on the security’s price. When we examine municipal bond market liquidity today compared with levels that existed prior to the financial crisis, we see a small reduction, but not the large decline that is often discussed in the press. Trading volume remains high and bid/offer spreads are actually tighter than in the past. Both indicators support improved liquidity.
With respect to the management of our funds, we have had a longstanding policy to maintain reserves in the municipal bond funds to be prepared at all times for a sudden and large volume of shareholder outflows. Specifically, we hold a minimum of 4% in securities that are cash or cash-equivalent (mature in less than 1 year) and a minimum of 4% in high-quality securities with maturities between 1 to 5 years. Since the funds are managed to a high credit-quality standard, we also own securities beyond 5 years that are some of the most liquid securities in the municipal market.
The size of our liquidity position was established through analyzing historical periods of shareholder redemption activity and the inherent liquidity of the municipal market. Over the past 25 years, the municipal market has experienced numerous periods of elevated redemption activity (e.g., the Taper Tantrum of 2013, Meredith Whitney’s 2010 alarmist default call, the rate increase of 1994), and our reserve policy served the funds well in each of those episodes. While it’s likely that another period of large outflows will occur at some point, we remain highly confident that the funds are well-positioned for such an environment.
Do expense ratios include transaction costs?
No. Expense ratios reflect the annual operating expenses of a mutual fund, including advisory, administrative, distribution, and other costs. Expense ratios are expressed as a percentage of a fund’s assets and published in the prospectus, which also features a table illustrating the expenses an investor would pay on a hypothetical $10,000 investment over various time periods.
The transaction costs incurred when a fund buys and sells stocks and bonds is not included in the expense ratio, nor is it reported explicitly. Such transaction costs include commissions, spreads, and market impact, which are difficult to quantify accurately in a standardized manner. These costs are, however, reflected in a fund’s total return. As such, fund managers have strong incentive to execute trades efficiently and effectively.
Note that the greater the volume of buying and selling by a fund, the greater the drag on the fund’s return. Thus, a fund’s portfolio turnover rate can give you some indication of the potential impact of transaction costs on returns.
Why are there only two classes of fund shares for retail investors?
Actually, there are three share classes designed to meet the needs of individual investors: Investor, Admiral™, and exchange-traded fund (ETF). Investor Shares generally require a $3,000 minimum initial investment, with the exception of Vanguard Target Retirement Funds and Vanguard STAR® Fund, which require $1,000 to open an account.
Investors entrusting higher amounts ($10,000 for most index funds, $50,000 for most active funds, and $100,000 for sector index funds) qualify for our ultra-low-cost Admiral Shares.
Also, 70 Vanguard index funds offer an exchange-traded share class that affords a greater degree of trading flexibility than our traditional mutual fund shares. You can learn more about our ETFs here.
I hope to answer additional questions in an upcoming blog post. In the meantime, thank you for entrusting us with your savings and for supporting the Vanguard way of investing.