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