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Stock market highly valued: Vanguard CEO

Stocks are highly valued and that means investors can expect returns lower than long-term averages over the next decade, Vanguard Group CEO William McNabb said Thursday.

"We think stocks are valued at really kind of the highest decile if you look at historical returns and what that suggests to us … over the next decade, stock returns are likely to be a couple hundred basis points below long-term averages," McNabb said in an interview with CNBC's "Power Lunch."

His comments came a day after Federal Reserve Chair Janet Yellen warned the market valuations were "quite high."

Meanwhile, as the market braces itself for the inevitable hike in interest rates by the Fed, McNabb said a lot will depend on how quickly those rates rise.

"Our best sense is that the rate increases will be relatively metered out, if you will, and be fairly steady and gradual and probably in smaller increments than a lot of people anticipate," he said. "I think investors will be able to handle that."

Read MoreYellen was right, markets are overpriced: Shiller

William McNabb, chairman, president and chief executive officer of Vanguard Group
Tim Boyle | Bloomberg | Getty Images
William McNabb, chairman, president and chief executive officer of Vanguard Group

He also believes index funds will continue to outperform actively managed funds. From 2007 to 2014, index funds saw inflows of $1 trillion, while actively managed funds saw outflows of $659 billion.

"It's the triumph of low-cost investing, and I do think that's a secular trend and it's a trend that's going to continue," McNabb said.

"From our perspective, it's a very, very difficult thing for an active fund to outperform an index fund because of the cost differential."

However, the CEO was humble when it came to declaring victory over the Pimco Total Return Fund, which recently ceded its title of the largest bond fund to the Vanguard Total Bond Market Index fund.

"For us, the only thing that matters is getting up every day and doing a great job for our investors," McNabb said.

"To see it where it's at is gratifying. It means the message is resonating."

Read MoreAs rates rise, the biggest buyer of stocks may back off

McNabb also had another message for investors. On Thursday, he wrote an op-ed in The Wall Street Journal warning mutual-fund investors they may be subject to a new tax, courtesy of financial regulators who could decide certain mutual funds pose a systematic risk to the financial system.

He was referring to a proposal that would apply what is known as the fiduciary standard to mutual funds and the advice the firms give.

"Don't apply bank regulations to nonbank business model," he said.

Under current regulations, banks with more than $50 billion in assets are designated as systemically important financial institutions.

"We think there are certain activities out there that could be potentially systemically important. Those activities should be looked at," he said. "But merely designating a firm or a fund because it is large actually seems counterintuitive to us."

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