Vanguard goes all alternative

The Bogleheads forum is buzzing with news that Vanguard has set up an Alternative Strategies Fund in Dublin and filed for “exemptive relief” to allow its US Managed Payouts Funds to invest in the newfangled creature.

Vanguard is cherished by its investors partly for sticking to simple investing formulas that keep costs as low as possible. It is unsettling for them to see the mutual fund group setting off down a path labelled “alternative”. It smacks of hedge funds and other horrors.

Vanguard says it has been talking about setting up an absolute returns vehicle for two years, since it first launched the Managed Payouts Funds. It may or may not invest in the new fund if and when it gets the go-ahead to do so from the Securities and Exchange Commission (which could take months, perhaps years).

The Alternative Strategies Fund itself will use various strategies. There are six currently, although one is temporarily inactive, according to the filing. Each strategy aims to produce investment returns with two characteristics:

1. Performance over the long term comparable to, but independent of the direction and timing of, US stock returns; and (2) volatility that is similar in magnitude to the historic volatility of the US stock market.

To the extent that a strategy contemplated for use in the Alternative Strategies Fund is expected to exhibit lower volatility than the historic volatility of the U.S. stock market, the Alternative Strategies Fund will use leverage to adjust the volatility and expected returns of these investments to targeted levels.

The fund has been created solely for possible use in the Managed Payout Funds, says Vanguard. It has no “current” plans to sell the Alternative Strategies Fund to any investors in any other markets.

It is tight-lipped about exactly what the strategies are and how they work, saying only that they are run in-house by the quantitative equity group.

It is a sign of the times that Vanguard is going in this direction.  Diversification is still seen as the way to better risk/return outcomes, even if it didn’t do so well in the credit crisis. The mutual is a long way from turning itself into a hedge fund outfit – but perhaps it can beat the hedge funds at their own game. If it can provide absolute returns at low cost, that has to be good news for investors.

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Pauline Skypala has been editor of FTfm for four years having previously been deputy personal finance editor. She joined the FT in 1999 and has been writing on savings and investment issues throughout her career.

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Ruth Sullivan has worked as a financial/business journalist and foreign correspondent and for the past 10 years has been at the FT.