WEEKLY BRIEF | Is 5% Really That High?

Hello, and welcome to the IVA Weekly Brief for Wednesday, September 30.

There are no changes recommended for any of our Portfolios.

At the risk of stating the obvious, bond yields are rising. The 10-year Treasury bond now yields more than 5%, and a lot of the commentary I've seen describes the benchmark bond's yield as hitting “levels not seen since the peak of the 2000s housing bubble.”

That's accurate. But the framing suggests that 5% Treasury yields helped cause the global financial crisis, or that a crash and recession are coming.

I don't buy it. More precisely, if a downturn is ahead, I doubt 5% Treasury yields will be the culprit. In the 1990s, the 10-year Treasury yielded 6.66% on average, and the economy grew 3.6% per year (after inflation) while the stock market boomed.

I understand where some of the recent anxiety comes from. If you only started investing after 2007, a 5% Treasury yield may feel extreme. But history shows it's not. And for anyone buying bonds or bond funds today, higher yields mean more income going forward.

Right now, my bond fund preference leans toward keeping it simple and stable with a money market fund. But Premium Members can read the arguments for and against bonds in depth here.

One Down, Two to Go?

Yesterday, Vanguard fired Wellington from Long-Term Investment-Grade (VWESX)—a fund Wellington has subadvised since it launched in 1973.

Wellington ran the fund alone for 40 years. Vanguard took over a small sleeve in 2013, and from then until mid-2024 Wellington managed about 80% of the assets and Vanguard about 20%. Since then, Wellington’s share of the portfolio has been whittled down as Vanguard's share has grown, reaching about 40% at the end of June. Now Vanguard will run the whole thing.

I don't think shareholders will notice a difference. Vanguard has a deep fixed-income team, and it's had a hand on the wheel here for more than a decade.

The bigger question has to do with Wellington’s continued role in Vanguard’s bond funds. How much longer will Wellington continue to subadvise GNMA (VFIIX) and High-Yield Corporate (VWEHX)? It may only be a matter of time before Vanguard runs all of its bond funds in-house.

Manager Musical Chairs

That wasn't Vanguard's only manager change. Yesterday, it added co-managers across funds run by its in-house quantitative team—effectively anointing Cesar Orosco and Scott Rodemer as the outfit's leading figures.

Sharon Hill picked up two new responsibilities, Commodity Strategy (VCMDX) and Global Minimum Volatility (VMVFX). Meanwhile, Orosco and Rodemer joined each other's funds. The duo now co-manage the Strategic Equity funds, the Factor ETFs and Vanguard's sleeve of Explorer (VEXPX). They’ll also co-manage Vanguard’s upcoming actively managed stock ETF, U.S. Small-Mid Cap Active ETF.

Again, shareholders shouldn't lose sleep over these moves. At funds where computer models pick the stocks and build the portfolio, the names in the prospectus still matter, since someone has to program and oversee the models. But they matter less than they do at a traditional stock-picking fund.

The bigger question for you and me is whether any of these funds are worthy of our money. The new managers' own holdings offer a hint. Orosco has between $100,001 and $500,000 invested in Equity Income (VEIPX), and Rodemer has the same amount in Market Neutral (VMNFX). 

I rate the diversified mutual funds and ETFs Holds, but give Commodity Strategy and Market Neutral Sells. Rodemer's stake in Market Neutral doesn't change my view: a manager's conviction doesn't make a fund a good fit for most investors' portfolios.

A Note from Legal

What’s the cost of reporting the wrong cost basis for over a decade? For Vanguard, about $2.85 million, and counting.

Last week, the Financial Industry Regulatory Authority (FINRA) fined and censured Vanguard for sending customers inaccurate cost basis information on account statements, trade confirmations and 1099s from roughly 2012 to 2023.

The errors came from Vanguard's systems and those of an outside vendor it worked with. They goofed in three different ways:

1. Sometimes, when new cost data arrived after a customer had already sold part of a position, the vendor's system rewrote the history. It would show the wrong tax lot as sold, even overriding customers' specific-lot instructions.
2. Some share class conversions mixed up cost basis data across different funds.
3. And because Vanguard and the vendor rounded share counts to different numbers of decimal places, the two systems sometimes disagreed on how many shares a customer held.

That rounding problem accounts for the headline numbers: About 100,000 accounts and up to 5.7 million statements affected. In almost all cases, though, the discrepancy was less than one share. The lot-selection errors were fewer (about 6,000 transactions), but they caused some investors to overpay or underpay their taxes.

To Vanguard's credit, the case started with a self-report. But FINRA also found that Vanguard failed to reasonably investigate red flags, including at least 25 written customer complaints. It didn't systematically fix the lot-selection problem until 2023.

Vanguard agreed to a $950,000 fine. It also voluntarily paid about $1.9 million to customers who may have overpaid taxes, had to refile returns or needed to pay a tax professional to sort things out.

This isn't Vanguard's first run-in with FINRA over bad statements. In 2023, it paid $800,000 over inaccurate money market yield and investment return figures.

Vanguard's tech troubles have been well documented here and in other journals for years. The fines are a rounding error for a firm Vanguard's size—the lost trust of longtime clients is harder to value.

This isn't the end of Vanguard's legal troubles. A class action suit was filed over Vanguard’s move to charge fees for paper statements. Vanguard isn't the only target: Morgan Stanley (think E*TRADE) and Pershing are also in the crosshairs.

I'm not a lawyer, so I won't guess how that suit plays out. But the bottom line holds: No one cares as much about your money as you do—not even Vanguard. I don’t expect you to audit every tax lot, but if a gain or loss on your 1099 looks off from what you'd expect, it's worth a call to Vanguard before you file.

Our Portfolios

Our Portfolios are showing solid returns for the year through Tuesday. The Aggressive Portfolio is up 14.0%, the Aggressive ETF Portfolio is up 11.7%, the Growth Portfolio is up 12.9%, the Moderate Portfolio is up 11.9% and the Conservative Portfolio is up 6.9%.

This compares to a 12.9% return for Total Stock Market Index (VTSAX), a 14.2% gain for Total International Stock Index (VTIAX), and a 2.6% decline for Total Bond Market Index (VBTLX). Vanguard’s most aggressive multi-index fund, Target Retirement 2070 (VSNVX), is up 11.9% for the year, and its most conservative, LifeStrategy 20/80 (VASIX), is up 0.9%.

IVA Research

Yesterday, I took an early look at how Dividend Growth’s new managers are reshaping the fund—and why, so far, it looks more like an evolution than a revolution.

Until my next IVA Weekly Brief, have a safe, sound and prosperous investment future.