Should you invest in Vanguard LifeStrategy funds?

The Vanguard LifeStrategy range is a family of five funds with different levels of potential risk and returns, constructed by blending a variety of passive funds together. In contrast to ‘active’ funds that employ fund managers to try and select the best-performing investments, passive investments or ‘trackers’ simply aim to replicate the returns of an index, say, the FTSE 100 representing the UK stock market.

How LifeStrategy Funds work

Each LifeStrategy fund offers cost-efficient exposure to a simple, diversified portfolio and is automatically rebalanced to maintain a specific asset allocation. At one end is the riskiest, LifeStrategy 100% Equity, which is solely invested in shares. LifeStrategy 20% Equity is most cautious in terms of its allocation with 20% shares and the rest in bonds.

Bonds are usually less volatile because they represent loans to companies and institutions rather than an actual slice of a company in the case of shares. Broadly, the higher the allocation to equities the riskier the portfolio in terms of ups and downs, though (as noted below) there can be time periods that represent exceptions to this general rule.

The set allocation of each fund saves the investor from rebalancing the weights of various funds or investment areas themselves. It prevents over or under-exposure to areas that do particularly well or badly, which helps prevent the risk level from drifting over time. All the funds in the range invest in a number of Vanguard's low-cost index trackers, providing access to thousands of international stocks and bonds across major markets to create a truly diverse portfolio.

Table: List of Vanguard LifeStrategy Funds available through the Charles Stanley Direct Investment Service (either as income or accumulation units):

• Vanguard LifeStrategy 20% Equity
• Vanguard LifeStrategy 40% Equity
• Vanguard LifeStrategy 60% Equity
• Vanguard LifeStrategy 80% Equity
• Vanguard LifeStrategy 100% Equity

For those looking for a good-value, low-maintenance and broadly spread portfolio a LifeStrategy Fund could help form a simple and inexpensive ‘core’ in a portfolio around which other investments can be added to personalise. However, like any investment, it should be reviewed periodically to ensure it continues to meet objectives.

Fund characteristics evident in recent performance

While there are significant advantages to the simplicity of this fund range, there are also some aspects investors should be aware of. Firstly, although exposure to bonds has historically had a dampening effect on the more volatile returns from shares (generally because bonds can weather recessions better than equities), this hasn’t been the experience over the past year. Both bonds and shares have fallen and, unusually, bonds have fallen more than shares, which has led to the more bond-heavy LifeStrategy funds declining more than the ones mostly or wholly devoted to equities.

The reason for this was the dramatic shift in inflation expectations and the anticipation of much higher interest rates necessary to curb price rises. This meant a significant ‘reset’ in the value of almost all assets to provide investors with the higher return they demand from a different outlook. The higher inflation and interest rates go, the more investors require in terms of return from financial markets, and bonds are particularly sensitive to this effect because they typically have a low, fixed level of return. It isn’t a problem confined to the LifeStrategy range, it has affected all funds to one degree or another, though adding some more specialist investments for further diversification potentially could have helped.

Performance has also been hampered by a ‘home bias’ in recent years. Although the share component of the funds is global, the funds are for UK investors so there is a bias towards domestic companies. It’s about a quarter of the share component of each fund, which is considerably higher that the UK’s weight in major global share indices, which is about 4%. The UK market has been a laggard over the past decade, especially versus the dominant US markets, though it has been more resilient in 2022. That’s mainly because of its high level of exposure to the recently strong-performing energy sector and the benefits of the weak pound, which has flattered the UK’s overseas earners reporting in sterling.

Currency moves have also had a broader impact on relative returns within the LifeStrategy range. The fact that bond exposure is currency hedged and equity exposure is unhedged has exacerbated the outperformance of the equity-heavy funds versus those more exposed to bonds. The former haven benefitted more from a weaker pound making overseas assets more valuable. A reversal of this trend, a stronger sterling, would tend to assist Vanguard LifeStrategy 20% Equity versus the others, though currency moves tend to play a secondary role in returns from asset classes over the longer term.

Table: Discrete annual returns from the Vanguard LifeStrategy range

Past performance is not a reliable indicator of future returns. Figures are on a % total return basis, bid to bid price with net income reinvested; Source: FE Analytics, data to 31/10/2022.

The outlook from here

There is a risk that inflation expectations keep on rising in the short term, which would clearly be a difficult scenario for the simple, mixed portfolios on offer in the Vanguard LifeStrategy Funds. However, this is unlikely to continue into the longer term. Central Banks are doubling down on their determination to quash rising prices and although a difficult period of transition awaits, from this point things are starting to look brighter. Inflationary pressures appear to be easing and when clear evidence emerges they are moderating, central banks can ease off hiking interest rates to tame runaway prices. That means the headwind to returns we have experienced this year could abate, and in a more optimistic scenario for asset prices, it could happen quite quickly.

We can take some comfort from energy and commodity price falls in recent months and that supply-chain pressures have started to ease. Markets are forecasting inflation will be quite stubborn and interest rates will peak at over 5 percent next year. However, at some point attention may turn to support the economy through lower rates as better news on inflation comes through and, quite possibly, as economies start to flag. In this scenario bonds, particularly those with lower credit risk could perform well. At any rate, the income available from bonds is now greater, and from this point, the higher income stream provides some cushion against higher inflation and interest rate expectations.

Shares should also benefit from lower interest rates, but their resilience will also be shaped by the outlook for the economy which may not be rosy as higher rates take their toll on economic activity. While it may take longer for shares to start to perform, the diversification benefits of shares versus bonds is likely to be re-established.