(PUB) Investing 2016

been 11 days this year when the 10-year Treasury bond’s yield moved 5% or more from the prior day’s yield, which is equivalent to all the 5% or greater moves seen in 2015, and higher than the eight such moves in 2014 and 2013 combined. With yields at such low levels, even small absolute changes represent big percentage moves. The concern for investors is that low yields mean that there isn’t much income to cushion the blow of falling bond prices when interest rates rise. Which begs the question: When will rates rise, and how fast? No one knows, though plenty of talking heads will tell you they do, with absolute confidence. Those are simply guesses. What isn’t a guess is that higher rates are likely to be driven by faster economic growth or higher inflation or both. Right now, though, the economy is growing at an uninspiring pace. Second-quarter GDP was revised down from 1.2% growth to 1.1%. And inflation is still extremely low. The Fed’s preferred inflation mea- sure, core PCE, is only up 1.6% over the past year. >

Still, I think it’s likely that the Fed will raise interest rates in September, though we are only talking about an incremental increase. Chair Janet Yellen and some Fed governors have tele- graphed to the market that they would like to raise interest rates, though ever so slowly. Remember, the last time the Fed raised interest rates was in December, so they haven’t been in a hurry. I sup- pose it is possible, but I wouldn’t expect a 25 basis point (0.25%) move to trigger materially higher yields across the bond market. Nor would it cause me to alter the Model Portfolios —even in a period of rising interest rates, there is a role for bonds in keeping overall volatility under control. As noted earlier, there still seems to be a good deal of negative sentiment toward stocks, particularly U.S. stocks, which I believe reflects the memory of two massive bear markets over the last two decades—the bursting of the tech bubble, and then the credit crisis. And while still relatively unpopular, some of the best areas of opportunity may be found outside our borders. Yes,

the headlines are scary, but consider that Emerging Markets Stock Index , which is up 14.6% this year, is still 19.6% below its high point reached nearly nine years ago in October 2007. International Growth , my preferred foreign stock fund, currently has 20.6% of its portfolio allocated to companies in emerging markets, a bit more than Total International Stock Index ’s 18.7% allocation. Its 6.1% return this year is also slightly ahead of the index fund’s 5.2% return. At some point we may want to increase our exposure to foreign stocks—with or without a dedicated emerging markets holding. On a side note, August marked the 40th birthday for 500 Index ,Vanguard’s first foray into indexing. When it was introduced, with a 6% front-end load, it was an abject failure, and attracted few assets even after the load was removed. Of course, that failure turned into a rousing success and gave birth to the “new” Vanguard, a no-load, low- expense home for a slew of index and active funds as well as ETFs. We are all better for it. n

VANGUARD’S HEDGE FUND turned one year old in August. Wait. Vanguard has a hedge fund? That’s right. Alternative Strategies is essentially a hedge fund in a mutual fund wrapper, execut- ing a sophisticated, somewhat opaque strategy with limited access and the aim of delivering positive returns irrespective of the stock market. Alternative Strategies has everything but high fees, or a high profile. You are forgiven if you’re not all that familiar with Alternative Strategies. You can only invest directly in the fund if you are a client of Vanguard’s Institutional Advisory Services, which means you are an endowment, foundation or pension. You won’t even find a page for the fund on Vanguard’s personal investor website. That said, Alternative Strategies is a component of Managed Payout ’s portfolio—so it deserves a bit of our time and attention. Alternative Strategies’ objective is to deliver returns that have a low correlation to the stock and bond markets while exhibiting less volatility than stocks. In plain English, that means the fund should behave differ- ently than the stock and bond funds you already own, and it should land in the middle when it comes to risk. Of course, the real aim is to do this while also generating positive returns, regardless of what the stock or bond markets are doing—Vanguard’s goal is to return 4% over cash— otherwise you could just hold cash and get about the same diversifica- tion benefits with no risk (and almost no returns). ALTERNATIVES A Strong Start, Still in the Shadows

Portfolio managers Michael Roach, Anatoly Shtekhman and Binbin Guo try to deliver on this fairly lofty goal by investing in several differ- ent strategies: long/short equity (which is like Market Neutral ), event driven (also known as merger arbitrage), fixed income relative value, currencies and commodities. If that sounds a bit murky in its description, well, that’s because it is. Vanguard could stand to improve its discussion of how this fund actually invests. That said, the fund’s first year has been a home run. Since its August 11, 2015 launch, Alternative Strategies’ 9.6% return is ahead of Total Stock Market ’s 5.6% gain, Total Bond Market ’s 5.5% advance and Prime Money Market ’s meager 0.3% return. Alternative Strategies has delivered those returns with low correlation to the stock and bond markets. Remember, correlation tells us to what degree two funds (or, say, a fund and an index) moved in the same direction at the same time. Correlations range between -1.00 and 1.00. When two invest- ments rise and fall in perfect unison, they are said to have a correlation of 1.00. If they always move in opposite directions, that yields a correlation of -1.00. Since inception, Alternative Strategies and Total Stock Market have had a correlation of 0.05, which means there was little relationship between their ups and downs. A correlation of 0.33 between Alternative Strategies and Total Bond Market indicates there has been a bit more of a synchronicity, but they still moved fairly independently of each other.

4 • Fund Family Shareholder Association

www.adviseronline.com