Vanguard To Shut Down Factor ETF

Vanguard will liquidate its $43 million Vanguard U.S. Liquidity Factor ETF in November, the firm announced this week. It’s the first time in its 20-year history of launching ETFs that the Malvern, Pennsylvania, giant has shut one down.

The fund is the smallest in a six-fund suite of factor-tilting products that launched in 2018. Altogether, the entire suite had about $3.4 billion in assets as of the end of August, the firm noted.

But the dissolution of the Liquidity ETF may hint that the popularity of factor funds is fading. The idea behind factor funds is that by overweighting a portfolio toward stocks with certain characteristics—low PE ratios, good recent performance or low volatility—it could outperform the market. Any given factor will have ups and downs, but the long-term trend should be positive. And there are reams of academic analyses of past market returns which claim to isolate and quantify the boost you could get in your returns by overweighting a given factor.

In the real world, results have been lackluster. U.S. Liquidity Factor returned 7.1% during the three-year period that ended in August, trailing the fund’s stated benchmark, the Russell 3000, by 4.8 percentage points, according to Vanguard’s website. The fund’s year-to-date declines of 16.9% are similar to its index. Of the factor suite, only the U.S. Momentum Factor ETF has stayed on par with Total Stock Market ETF since the funds’ inception in February 2018.

Add the departure of its founding portfolio manager to poor performance and a tiny asset base, and it’s no surprise that Vanguard opted to close the door on the fund.

At the end of the day, it could simply be that investing in illiquid stocks may be a strategy beloved in ivory towers but of little interest to most investors, and therefore an unworthy addition to Vanguard’s lineup. And we wouldn’t be surprised if some of the other factor funds also proved to be on their way out; U.S. Minimum Volatility ETF had only $69 million in assets as of last month.

Signal From Static: The Chairman’s View

By Daniel P. Wiener, Co-founder and Chairman

Adviser was founded in 1994 because investors demanded an independent, uncompromised view on the markets, the economy and their finances, delivered in both words and actions. We have tried to live up to those demands and have been rewarded with fantastic clients and a terrific team of people to help them.

In Signal From Static, a new feature, I’ll try to take a broader view on issues and questions of finance, cutting through a lot of the noise and keeping an eye on how events impact investors. I hope what I have to say will be of interest, and if I ever fail or miss a particular topic you want me to focus on, please email me at signal@adviserinvestments.com.

An Inflated Perspective: Why 2%?

Consumers, as well as investors, have become obsessed with inflation (the media certainly has helped). I’m not surprised. After decades of prices rising at a snail’s pace, the measure has shot higher, with the headline consumer price index (CPI) hitting 9.1% in the year ending in June. (It has since fallen to 8.3% but that’s not a win as yet.) The monetary policymakers at the Federal Reserve have begun to battle inflation with interest-rate increases, and their goal is 2% inflation sometime in the next two years.

You might wonder where that 2% figure came from. It was only in 2012 that the Fed agreed to publish a target for its policymaking. Prior to that decision there was disagreement about whether it should target anything. The 2% figure, which is based on the headline personal consumption expenditures (PCE) measure rather than the CPI, has become an international standard of sorts, according to researchers at the St. Louis Federal Reserve. Several countries have adopted 2% as their inflation targets as well.

As investors, we need to put the Fed’s target in perspective. I believe they are setting an unrealistic goal for policy. Inflation at 2% would be significantly lower than Americans have seen, on average, for decades. In fact, I believe the only reason many of today’s pundits think a 2% inflation level is the “right” target is because they are suffering from recency bias. Since the end of the Great Recession in June 2009, PCE inflation has averaged 1.87%, inclusive of 2022’s recent inflationary spike. Ignore the past 12 months and the Fed’s favored inflation measure has averaged just 1.53% since 2009.

Inflation has been abnormally low for more than a decade. This gives the Fed cover for its 2% figure. Why do I say that? Because since the PCE was first calculated in 1960, inflation has averaged 3.27% over more than six decades. A goal of 2% inflation may be laudable, but that doesn’t mean it’s obtainable.

Investors and consumers must recognize that even if inflation doesn’t fall to 2%, the economy will not go into a tailspin, and we won’t be forced to buy generics to keep our household budgets under control. Incomes are rising and bonds are paying much higher rates of interest today than we’ve seen in over a decade. Forward-looking inflation expectations are reasonable, but they aren’t at 2%.

Investors are often biased by recent experience. If the markets have been strong, they expect them to remain strong. If they’ve been weak, that weakness is expected to continue as well. Those are the biases we must contend with. The same applies to inflation. We may have been through a period of below-average inflation; now we’re faced with a period of well-above-average inflation. The pendulum is already swinging back in favor of lower price increases. Will inflation reach 2%? I have no idea, but I’m not going to hold my breath.

In the meantime, as with stocks, the only thing we need now is patience.

Until my next static-clearing signal…

Dan Wiener

Chart of the Week: How Low Do We Go?

The S&P 500 index is down about 10% over the last month, and this week it sank below its June low; we could be in the midst of another decline in this bear market. Of course, it’s impossible to “know” whether stocks will put in a new low point or not. So, I wanted to look at past bear markets as a guide.

Since 1970, there have been eight bear markets, including the current one, as defined by a 20% or greater drop in the S&P 500 (including dividends). On average, the S&P 500 fell 39% during a bear market and it took about 15 months to reach that low point. The index took nearly twice as long (27 months on average) to recoup those losses. That means that the average bear market from peak to trough and back to peak lasted three and a half years.

In the current bear market, stocks have declined 23% at their worst, and it took just six months to hit that low-water mark (January through June). As it stands, this has been a relatively mild bear market—even if it hasn’t felt like it in real time. That doesn’t mean stocks have to continue declining, but history tells us to be prepared for that possibility.

Of course, trying to describe an average bear market is a bit of a fool’s errand. No two bear markets are alike. The most recent COVID-19 bear market was over in less than six months, while the bear market in the 1970s lasted for over seven years.

Plus, the 20% decline bear market definition is an arbitrary round number. In this week’s table, I also included three periods where the S&P fell more than 19% but narrowly avoided that 20% threshold. Should those count as bear markets? I’d argue they should, but your mileage may vary. Those declines just shy of 20% were short-lived.

Note: Based on daily S&P 500 TR from 1/1/1970 through 9/16/2022. Source: Bloomberg

Adviser’s Takeaways

In a recent Takeaway, Senior Research Analyst Liz Laprade discussed how past bear markets can help us understand today’s. And in our new Animated Adviser series, Manager of Financial Planning Andrew Busa talked about the importance of pouring your money into a savings waterfall.

We hope you find these episodes engaging and accessible, and please let us know if there are any topics you’d like us to address by sending an email to info@adviserinvestments.com!

About Adviser

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