Vanguard exec shares outlook, fears bond bubble


Associated Press

Posted on December 20, 2012 at 6:02 PM

Updated Thursday, Dec 20 at 6:02 PM

BOSTON (AP) — The name George "Gus" Sauter may not ring a bell for most investors. But it probably should, because Sauter may very well have influenced how their retirement funds are invested.

As Vanguard's chief investment officer, Sauter has been instrumental in guiding the company to become the largest mutual fund provider and one of the industry's fastest-growing firms, despite its size.

He joined Vanguard in 1987, just as index fund investing was beginning to really catch on, and just over a decade after Jack Bogle founded the company. Bogle became an outspoken advocate for index investing, the no-frills approach of owning all the stocks in a market index. It's a way to minimize costs by avoiding the higher fees charged by professional stock-pickers who fail to beat the market more often than not.

Sauter expanded both the index and actively managed mutual fund lineups at the Valley Forge, Pa.-based company, and led its move into exchange-traded funds in 2001. Two years later, he was named the company's first-ever CIO. Sauter has enhanced Vanguard's reputation as the industry's lowest-cost provider, leading initiatives to cut everything from trading expenses to in-house operational costs.

Vanguard's managed assets exceed $2 trillion, double the total just three years ago. Although many rivals have seen clients continue to withdraw their money, Vanguard attracted $130 billion in net deposits through November. That tops the company's previous full-year record set in 2007.

In June, Sauter announced plans to step down at year-end, and hand over the CIO responsibilities to another Vanguard veteran, Tim Buckley.

At 58, Sauter is young to retire. He's taking a few months off to consider new opportunities, perhaps teaching at a university level, or otherwise promoting financial education to average investors — perhaps targeting professional athletes who all too often stumble when managing their money.

In an interview this week, Sauter discussed his career and his outlook for the market. He's optimistic about stocks. That's one reason why he's aggressive with his own portfolio. Although he doesn't recommend it for others, he has allocated more than 90 percent to stocks, significantly above the level typically considered appropriate for someone his age.

Here are excerpts from the interview:

Q: We're almost at 2013, but what's your outlook for the stock market, say over the next 10 years?

A: The best predictor of future returns is what you're paying for earnings. And valuations now are quite reasonable. (Eds note: Stocks in the S&P 500 are trading at an average of about 14 times earnings over the past 12 months, below the 10-year average of about 15). So stocks are a bit cheap, and you can expect a reasonable return over the next decade — maybe 6, 7, 8 or 9 percent a year, something in line with the historic average.

Corporate earnings are the key factor to look at. Lots of people make the mistake of thinking stock returns are tied to economic strength. But the data don't corroborate that. And the interesting thing about corporate profits is that they are blind to national boundaries. More and more, companies are global, and earnings growth is really independent of the strength of one country's economy.

Q: What about the outlook for bonds?

A: The best predictor is the current yield to maturity. The yield now on a 10 year Treasury bond is a little under 2 percent. So you might expect 2 to 3 percent a year from a bond portfolio. That's if you include some higher-yielding bonds where's there's greater credit risk than in the Treasury market. Two to 3 percent is certainly less than we have experienced historically from bonds, and it's significantly less than what we've seen over the last 30 years of a bull market for bonds.

Q: Investors have added more than $1 trillion in cash to bond funds since the 2008 financial crisis. What's the risk for investors who have moved much of their portfolio into bonds?

A: I'm worried. In some cases, these investors have been seeking yield, and in other cases they've been pursuing an investment they consider to be much safer than the stock market. Unfortunately, we may be seeing the bond market's version of 1999 and the run-up of tech stocks in the stock market. We're building a pretty big bubble in the bond market and bubbles just don't end pleasantly. A lot of investors could be disappointed. When the economy does start to strengthen, interest rates will go back up and bond returns will be disappointing, even negative.

Q: We're on the precipice of possibly going over the "fiscal cliff," with no deal reached yet between the White House and Congress to avoid automatic tax increases and spending cuts. Will actions in Washington continue to heavily influence the market?

A: The government has played a bigger role in the economy ever since the unfolding of the financial crisis. Certainly, the bond market has been influenced by the Federal Reserve's moves to keep rates very low. But in the stock market, I don't think the government has played as great a role. I cite this year as a perfect example. We've all been concerned about going over the fiscal cliff for a year now, and it certainly has intensified in the last three to six months. Yet the market continues to rally, and it's up 15 percent this year. Investors should think long-term and not get caught up with what is going on in the economy, or what the government is up to

Q: Do you have any regrets from your 25 years at Vanguard?

A: I regret not moving into ETFs stronger and earlier.

But there are a lot of misconceptions people have about ETFs. When they were introduced in the 1990s, they were portrayed as a new investment. In fact, they're just a new way to distribute an old investment, the index mutual fund. Early on, the bulk of ETFs were essentially index funds, and instead of dealing with the index fund provider, you merely bought it on a financial exchange.

Q: What mistakes have you made with your own investment portfolio?

A: Being too conservative when I first started investing as a young man. At that age, you have a long time horizon and should probably be more aggressive. I think that's a mistake a lot of young investors are making today. The data show that 20-somethings are much more conservative than 20-somethings were 10 years ago. That will make it difficult for them to reach their retirement goals.


Questions? E-mail investorinsight(at)