Using Vanguard Wellesley Income Fund (VWINX) As A Bond Proxy?

2009 May 28

Some time ago, I came across the idea of using the Vanguard Wellesley Income Fund (VWINX) as a proxy for bonds in an investment portfolio. For the life of me, I can’t seem to find the original forum post (I used to frequent a lot of investing forums, Morningstar being my favorite) which prompted the idea, but it has stuck with me for some time now. I have considered making the move myself a number of times, but have never pulled the trigger.

What Is Wellesley Income (VWINX)?

Wellesley Income Asset Allocation

The Vanguard Wellesley Income Fund (VWINX) is one of the best balanced funds you’ve never heard of. Somehow, it’s managed to stay under the radar since inception in 1970, despite its ability to turn out solid gains year after year after year. It’s lost money only once out of the last nine years, and even then performed much better than the broad market. I can only assume this lack of attention is due to the fact that balanced funds aren’t exactly anybody’s idea of a good time: they won’t make you rich, but they won’t make you poor either.

Wellesley Income invests approximately 60% of its portfolio in high-quality corporate bonds and the remaining 40% in large, steady, dividend-paying stocks. It yields a solid 5.54% an sports a low 0.33% expense ratio, making it among the cheapest and highest-performing balanced funds on the market.

Why Use Wellesley Income Instead Of Bonds?

The theory goes that bonds are meant to stabilize your porfolio and dampen the volatility inherent with the violent swings of the stock market. They are also meant to provide diversification benefits by zigging when stocks zag and vice versa. In this way, bonds can significantly reduce the risk of your portfolio without reducing returns too much. Wellesley Income seems to meet both of these requirements with higher returns and income than the average bond fund. How?

For starters, you have to remember Wellesley Income invests 60% of its portfolio in bonds anyway. So if your “bond” allocation is, say, 20% of your portfolio, you will continue to have about 12% of your portfolio in bonds even if you use Wellesley Income as a stand-in for a traditional bond allocation. Wellesley’s advantage is that it invests the rest of its money in steady, high-yielding large-cap stocks, which historically have behaved much like bonds have in the context of a portfolio. They offer two distinct advantages over plain old bonds, however: 1.) the potential for capital appreciation and 2.) rising dividend payments over time. A bond will never raise its interest payment, but a solid dividend-payer can be expected to do so regularly. So theoretically at least, aggressive investors can get the best of both worlds by using Wellesely Income as a bond proxy: the higher returns associated with stocks and the low volatility associated with bonds.

How Has This Worked Out In The Real World?

What good is all this theory if it hasn’t actually worked in the real world, you ask? Fortunately, it has…mostly. Over the past 36 months, Wellesley Income has recorded an R-squared of 0.77 relative to the total stock market, which means it’s a moderately good diversifier. That is, only 77% of the fund’s price movements over the past 3 years can be explained by price movements of the overall stock market. An R-squared of 0.85 or higher is considered to be highly-influenced by the overall market while an R-squared of below 0.70 means the fund doesn’t behave much like the market. At 0.77, Wellesley Income has been a decent but not great diversifier of risk compared to a comparable allocation to bonds.

Do I Recommend This?

I have thought long and hard about making this move myself in the past, but in the end decided not to. It is probable that aggressive investors who don’t mind the small extra risk associated with this plan will benefit from higher returns in the long run, but those investors probably wouldn’t bother with bonds to begin with. And conservative investors would probably prefer higher bond exposure and lower volatility than this plan would provide. Overall, it’s an interesting exercise in modern portfolio theory but it’s hard to imagine a real-life example where this might actually make sense.

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8 Responses
  1. 2009 May 28

    Thanks for the mention.

  2. 2009 September 29
    Anonymous permalink

    40% stock holdings is not a proxy for a bond fund period. Wellesey Income is a great balanced fund – but not a bond fund. Also currently Wellesey bond portfolio has higher maturity than average (compared to vanguard total bond), so its exposed to interest rate risk to a greater level. There is no free lunch.

  3. 2009 December 22
    Anonymous permalink

    I am considering loading up on shares of Wellesley. It outperforms most Target Retirement plans.

  4. 2010 June 16
    Lynn permalink

    I have admiral shares of Wellesley. I think it is one of their best funds by far.

  5. 2011 January 8
    John permalink

    I was advised to buy van. Wellesley income fund for my fixed portion of my portfolio.How can this be,if it has equities in the fund?

  6. 2011 September 17
    Bennet Cecil permalink

    Wellesley is the core with ten percent yearly returns since 1970. It recovered quickly from the recent financial meltdown and lets you sleep at night. Cash in your CDs and empty your savings account. Put it into this fund and watch it grow.

  7. 2012 March 26

    My wife and I have about 35% of our portfolio invested in this fund; all other funds are in various Vanguard funds. As our ‘CIO’, I love the Vanguard rep and also their stable performance. (wife thinks I’m doing a great job!) Over the years,this ‘safe’ investment has proven again and again to be quite the performer. Turtles and hares anyone? Your article is very informative except the part of not pulling the trigger-as you wait, we’re compounding.

  8. 2012 April 21
    Matt permalink

    John — My guess is that people are suggesting that you include a fund with equity exposure in your ‘bond allocation’ because IG bond yields are just so damn low in this market. That said, the overall asset allocation should be adjusted rather than just allowing your bond allocation to invest in equities. Meaning…rather than incorrectly considering this fund to be exclusively part of your fixed income allocation, your advisor should be explaining that your overall fixed income / equity allocation needs to be adjusted because our current low interest rate environment really prevents most fixed income instruments from yielding you anything meaningful. For example, change your overall bond/equity allocation from 60/40 to 40/60 and when adding this to your portfolio, consider the bond component part of your bond allocation and the equity component part of your equity allocation.

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