Vanguard Puts The Warning Into Words

| About: Vanguard Dividend (VDIGX)

Summary

Vanguard recently closed a dividend-focused fund to new investors.

It was a non-verbal cue.

Now the company's head of investment strategy is being more direct.

Not too long ago, Vanguard announced that it was closing the Vanguard Dividend Growth Fund (MUTF:VDIGX) to new investors. At the time I suggested this was an important sign that Vanguard saw big risks for dividend investors. Now the company is getting even more direct about the risks it sees in the future...

Closing a fund
A fund family can close a mutual fund for any number of reasons. When Vanguard closed Dividend Growth Fund to new investors, Vanguard CEO Bill McNabb said:

Vanguard is proactively taking steps to slow strong cash flows to help ensure that the advisor's ability to produce competitive long-term results for investors is not compromised.

You can read that in a couple of ways. One way is that there's too much money coming in the door for the fund manager to effectively invest in a time efficient manner. In other words, too much of a good thing. If that's true, then Vanguard hitting the pause button will give the fund time to put its cash to work and then it can reopen. No problems.

The other side of this coin is that you could also read the closure to say that so many investors are putting money into dividend paying stocks that there just aren't any bargains around in which to invest. In this case, every new dollar in the door is a weight on Vanguard Dividend Growth Fund because it either has to buy something it doesn't want to buy or sit on cash. Both can be risky issues, since cash earns nothing and buying inflated stocks could lead to negative returns if market dynamics shift.

Based on the market, I believe the choice to close Vanguard Dividend Growth was a glass half empty view of things. Understandably, some people didn't agree.

No doubt about it
Now, however, the company's head of investment strategy has come out and blatantly said there's risks you need to worry about. Joseph Davis, who's also the global chief economist at Vanguard, recently told Bloomberg that "The next five years are going to be more challenging than the previous five years in investing."

With the market near its all time highs, I think he's right. But there's more. Davis also said that investors need to, "Be cautious of trying to be heroic in this environment." What exactly does that mean? Pretty specifically, he's talking about taking on extra risk in a search for higher returns:

My main concern is, and what we're trying to make sure investors recognize, is that just given where we've been over the last several years, there's been this tendency to take more and more risk.

Notably, that risk includes investors looking for yield in places that they may have avoided before. Or shifting too much of their portfolios into one area just because the yields are relatively high compared to alternatives. For example, when asked during the Bloomberg interview about shifting out of bonds and into dividend paying stocks and REITs, Davis said:

That's an extremely dangerous game. They don't have the defensive characteristics of high-quality bonds. They're taking on undue risk that they're not necessarily appreciating.

The glass is half empty
In the end, I think my read on Vanguard Dividend Growth Fund's closure was spot on-Vanguard closed the fund because it sees trouble ahead for dividend stocks. That's pretty clear from what Davis has told Bloomberg. The question now is what you do with this information.

Perhaps the answer is that you are happy with your portfolio and there's nothing to do. That's fine, so long as you take the time to think about the downside risk Vanguard is talking about. If you think the concerns being presented by Vanguard, which I happen to think are quite real, are baseless, then I urge you to step back and listen more carefully to the dissonant view. Often you can learn more from those you disagree with than from those with whom you agree.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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