By Chris Flood, Chief Correspondent at ETF Stream
‘Skilled managers can find needles in haystacks and capitalise on megatrends-driven shifts’
Future investment returns will be determined by whether advances in artificial intelligence (AI) can outpace negative demographics and rising government debt, according to Vanguard, which is advising its 50 million clients to prepare for a world that will look very different from the economy today.
Investors will need to adapt their portfolios to be ready for two contrasting possible futures, says Vanguard’s chief economist Joe Davis in a new book titled Coming into view: how AI and other megatrends will shape your investments.
Davis presents two scenarios. A positive future in which successes in AI lead to an acceleration in human productivity and broad improvements in living standards, similar to the introduction of electricity at the start of the twentieth century. Or a more bleak future where AI innovation is overwhelmed by unfavourable demographics and rising government debt, leading to economic stagnation and weaker investment returns.
The easily digestible book, which Davis has peppered with some lively personal anecdotes and insights, is the result of an extensive research project into megatrends that have influenced US economic growth, inflation, and returns from equity and bond markets since 1890. Davis and several colleagues have also co-authored a formal academic paper, and Vanguard has also created a megatrends hub on its website in an effort to promote its analysis more widely.
Modelling by Vanguard suggests that adopting a “megatrends-aware” portfolio of US index-tracking funds should provide a modest improvement in returns – 6.3% annualised between 2027 and 2037 compared with 6% for a traditional 60/40 US equity bond benchmark – and also, more importantly, better downside protection no matter whether the spread of AI is a success or a failure.
The megatrends portfolio makes larger allocations to US value stocks and non-US international equities along with a heavier weighting of up to 50% in fixed income than the 60/40 US equity bond benchmark.
Davis goes further, arguing that allocations to actively managed funds should be incorporated in a megatrends portfolio. Vanguard’s founder, Jack Bogle, always recommended that investors should avoid active stockpicking as this is as rewarding as looking for a needle in a haystack and instead just “buy the haystack” by investing in a tracker fund that would closely follow the entire US stock market.
But Davis disagrees with Bogle’s stance, reflecting the active versus passive management debate that has continued within Vanguard since it was founded in 1975.
“Skilled managers can find needles in haystacks and capitalise on megatrends-driven shifts, such as changes in technology, demographics or globalisation,” writes Davis, who also wears a second hat as global head of the investment strategy group at Vanguard.
He suggests that up to 45% of the megatrends portfolio could be allocated to active mutual funds and ETFs.
A possible weakness of the book is that no further detail about how the allocations to active managers should be made beyond guidelines suggesting up to 20% in equities and 25% in fixed income. Davis suggests an investor that expects AI to transform society might look for an active growth manager that would specialise in searching for the next Amazon or Nvidia.
But key to this is identifying skilled active managers, and Davis admits that a reliable, quantitative framework “does not exist [today]to identify managers ahead of time who outperform”.
In fixed income markets, an active manager with a focus on security selection would also be Davis’ personal choice. This feels somewhat vague and perhaps Davis is underselling the considerable in-house active fixed income capabilities which Vanguard possess.
Vanguard also has relationships with more than 20 vetted external investment partners that run client money on its behalf, including Wellington, Baillie Gifford, Pzena, PRIMECAP, and Schroders.
An obvious question for any financial advisor or investor that is convinced by Davis’ argument is, “Can I do this today with an off-the-shelf Vanguard fund of funds/ETFs or model portfolio?”
The answer, somewhat disappointingly, appears to be not yet, as the closest offering – Vanguard’s time varying asset allocation model portfolio – does not include a megatrends version. And probably not for some time in Europe, given Vanguard’s existing fund range.
Another question is what shifts might follow across Vanguard’s business if investors did follow Davis’ advice about adopting a megatrends portfolio with active tilts.
Around 12% of Vanguard’s $9.3trn in long-term assets – excluding money market funds – are actively managed. A crude back of the envelope calculation suggests an additional $3trn could shift into active management if Vanguard’s investors uniformly were to adopt the megatrends portfolio with active tilts.
Although such a massive shift is unrealistic, it does suggest that Vanguard’s external investment partners could still enjoy a bonanza of new business if Davis’ megatrends advice is widely adopted.
This, in turn, raises questions about whether these external partner managers would have the capacity within their strategies to put this flood of money to work. More money would also probably have to flow to the private market managers, HarbourVest, and, more recently, KKR, with which Vanguard has partnered.
[This article was originally published on ETF Stream, June 25, 2025.]
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